Portfolio Construction
Building a Better Deep Value Portfolio: Difficulties Mastered are Opportunities Won
March 24, 2017
Topics - Portfolio Construction
The idea of opportunistic contrarian investing is appealing to many investors, yet in practice it has proven very challenging to implement successfully; even those who identify good opportunities can struggle with timely approvals, sizing of trades and forced exits at the worst possible times. We think deep value is best approached by pairing discretionary expertise with a quantitative framework that allows for broad screening of global opportunities and a rigorous approach to risk management. Implementing such a strategy may allow investors to successfully incorporate that elusive opportunistic element into their portfolios.
What's Inside?
This article defines “deep value” opportunities as ones in which valuation spreads are particularly wide relative to history, and discuss their causes, challenges and potential returns. We find:
- Deep value opportunities have numerous causes, often relating to behavioral biases, liquidity constraints and decisions made by investors for motives other than profit maximization.
- Opportunistic investing is challenging to implement successfully in investor portfolios in an ad hoc manner due to difficulties identifying opportunities, gaining timely approvals, sizing positions and holding on when markets move.
- A dedicated deep value strategy can potentially address the challenges of opportunistic investing by systematically screening across a broad opportunity set, sizing positions in a way that retains dry powder for periods when conditions worsen, and embedding conviction to hold positions until convergence.
- Our sample analysis indicates that such a strategy would have been profitable (even without the benefit of discretionary oversight), and in a way that could be additive to investor portfolios. In practice, such a strategy could further be improved by incorporating discretionary oversight to help differentiate great trades from value traps.
Conclusion
Many investors would like to add an opportunistic contrarian component to their portfolios, but face challenges in doing so. Pre-allocating to a dedicated “deep value” strategy which incorporates discretionary oversight in a systematic framework may be one solution that helps harness the profits from opportunistic trading in a way that diversifies existing portfolios.
This document is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein.
This document has been provided to you solely for information purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The factual information set forth herein has been obtained or derived from sources believed by the author and AQR Capital Management, LLC (“AQR”) to be reliable but it is not necessarily all-inclusive and is not guaranteed as to its accuracy and is not to be regarded as a representation or warranty, express or implied, as to the information’s accuracy or completeness, nor should the attached information serve as the basis of any investment decision. This document is not to be reproduced or redistributed to any other person. The information set forth herein has been provided to you as secondary information and should not be the primary source for any investment or allocation decision. Past performance is not a guarantee of future performance. Diversification does not eliminate the risk of experiencing investment losses.
This material is not research and should not be treated as research. This paper does not represent valuation judgments with respect to any financial instrument, issuer, security or sector that may be described or referenced herein and does not represent a formal or official view of AQR. The views expressed reflect the current views as of the date hereof and neither the author nor AQR undertakes to advise you of any changes in the views expressed herein.
The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Charts and graphs provided herein are for illustrative purposes only. The information in this presentation has been developed internally and/or obtained from sources believed to be reliable; however, neither AQR nor the author guarantees the accuracy, adequacy or completeness of such information. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. There can be no assurance that an investment strategy will be successful. Historic market trends are not reliable indicators of actual future market behavior or future performance of any particular investment which may differ materially, and should not be relied upon as such. Diversification does not eliminate the risk of experiencing investment losses.
The information in this paper may contain projections or other forward-looking statements regarding future events, targets, forecasts or expectations regarding the strategies described herein, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and may be significantly different from that shown here. The information in this document, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.