Luxembourg-based fund to buy stocks according to behavioural finance model
ABN Amro is to add a Japanese behavioural finance fund to its Luxembourg range. The fund will employ the behavioural finance investment techniques developed by the group and used in one of its Europe vehicles, launched in May last year.
The investment technique attempts to take into account and exploit the behavioural characteristics of investors. A dynamic, econometric model selects stocks by taking into account a number of factors and expressing these as a ratio.
Jurgen Peters, portfolio manager at ABN Amro, said: 'We try to identify companies that are undervalued based on the fact they project a poor image to the markets.
In just the same way, there are 'glamour' companies trading on an unwarrantedly high valuation. We believe a number are underrated more as a result of sentiment than for any fundamental reason.'
The companies are selected purely on a bottom-up basis and are not picked on the basis of being part of an undervalued sector.
Another important factor feeding into the model is overreaction. Peters said: 'This would cover situations where the market overreacts and de-rates the company on the basis of short-term bad news.'
Similarly, underreaction would cover situations where good news emerges that should affect the fundamental outlook for a company but where the information remains largely unrecognised. This creates a slow upward momentum in the price of the stock.
Peters said: 'Over-confidence is another important factor in the overall model. Often investors have a lot of confidence in their own predictions. Having made a decision, they tend to stick with it because they are reluctant to admit their initial mistake. To capitalise on this, we examine the earnings revision ratios of analysts.'
The dynamic nature of the selection process means the weight each of these factors is given in the model changes over time, according to the overall behaviour of investors at any given time.
According to Peters, the focus is always on stocks that are predicted to provide the greatest excess return relative to the market, rather than returns on an absolute basis. ABN Amro managers do not interfere with the outcome of the model.
He said: 'If we were to do that we might introduce our own behavioural characteristics into the equation, which would defeat the object. Sometimes we might have mixed feelings about what the model tells us but we stick to its decisions.'
The model suffers when the underlying factors change rapidly, before the model has time to accommodate them. The European version of the fund has lost around 22% over the last six months and took a sharp dip in the year to date.
This, according to portfolio manager Arjen Pasma, was due to sharp swings in investor sentiment against TMT stocks when they had already dropped substantially, and the sharp recovery in the same sector. Because of the dynamic modelling system that reweights the importance of the underlying factors the system tracks, fast switches in investor sentiment can cause problems.
The fund invests in eight of the most liquid and mature EU markets, including the UK, France, Germany, Netherlands, Spain and Italy. It simply buys futures in the other seven, where trading costs could exceed profitability. www.ifaonline.co.uk
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