Acadian believes that markets are inefficient, and that such inefficiencies are caused in part by systematic mistakes in investor behavior, as well as structural features of markets. To that end, Acadian applies fundamental insights in a quantitative investment framework to find attractive stock opportunities and to attempt exploit these anomalies. We believe that securities and markets have many attributes that are related to potential outperformance, and that a successful investment approach must be multi-faceted, applied across a broad opportunity set, and adaptable over time.
We believe that markets are inefficient because of the failure of investors to always act rationally. Investors have "mental models" of how stock prices are set, and due to external and internal psychological factors, these are often inconsistent with fair value. There is extensive empirical evidence of mispricings created by these mistakes, covering multiple time periods and across global markets. We believe a disciplined, objective approach is the best way to try to exploit these opportunities. Acadian also recognizes that markets are adaptive, that investment strategies go in and out of favor, and risk/reward relationships change over time. To that end, recognizing shifts in the market environment, and knowing the value of different pieces of information, at different points in time, across the markets where we invest, is essential to our success.
We leverage more than 60 individual indicators which have long-term evidence linking them to excess returns. These are combined into 18 aggregate factors which can be classified according to four key categories of Value, Quality, Growth and Technical. Each of these measures is grounded in sound investment theory, and supported by specific observations from a range of disciplines including statistical analysis, fundamental insights, economic science and behavioral finance.
Value - We favor companies that are undervalued in terms of a number of key fundamental value measures. The historical record from global equity markets provides remarkably consistent evidence that some stocks are temporarily underpriced, and offer good long-term value, while others are overpriced. These value concepts also help us identify underpriced markets, regions, and industries. Part of the behavioral underpinning for value investing is the tendency for investors to overpay for certain types of stocks based on optimistic expectations of future growth prospects. Over time, this effect can lead prices to deviate substantially from fundamental value.
Quality - There is strong fundamental and empirical support for investing based on financial quality - for instance the strength of financial statements, clarity and consistency of earnings data, or patterns of equity and debt issuance. Behavioral finance offers insights into why such quality measures work. Accounting policies can be complex, and investors tend unwittingly to take the mental shortcut of focusing on a few headline ratios and metrics, or on reported earnings. Some valuable information, which is harder to access and compare, can therefore be overlooked and lead to temporary deviation from fair value.
Growth - We seek to identify stocks with positive earnings growth characteristics and avoid stocks where growth prospects are deteriorating. Market inefficiencies are such that positive (as well as negative) news associated with growth takes time to be reflected in stock prices, providing the opportunity to exploit the resulting mispricing. Behavioral theory attributes this in part to a tendency toward psychological conservatism, “anchoring”, whereby investors are slow to abandon pre-existing beliefs, even in the face of compelling new evidence. In contrast, an objective and systematic approach is designed to identify the mispricing much more rapidly and capitalize on the opportunity.
- Our technical factors relate to information based on price, volume or similarly observed characteristics in markets. Momentum, for example, is closely tied to the "disposition effect" which is the tendency of investors to recognize gains aggressively in individual stocks, but allow losses to remain in their portfolios. The psychological foundation of the disposition effect is loss aversion - people find losses more painful than they find gains (of equal size) satisfying. This manifests itself in a reluctance to acknowledge paper losses in the hope that they will eventually turn into gains. Faced with good news, investors have an excessive tendency to realize their profit too early. These tendencies can result in slow or incomplete adjustment of prices to information, and hence generate momentum in stock returns.
Acadian's investment process is designed to adapt to the current environment, while incorporating historical trends. We adjust the weights on our stock selection signals to emphasize more heavily what we believe to be the most effective factors for the current environment. We also modify our process dynamically, focusing on measures that make fundamental sense, especially those that seem under-appreciated by other investors.
In building and monitoring client portfolios, Acadian applies a systematic portfolio construction process that takes into account a wide-range of data including proprietary internal risk modeling data, return forecasts, and transaction cost estimates in an attempt to maximize portfolio returns for a given level of risk.
In addition, we focus strongly on implementation using tools to trade off incremental expected return against implementation costs. We believe this discipline gives us an edge over investors who are less rigorous in converting stock ideas into trades.