The central thesis to our investment process is that certain key factors associated with individual stocks dictate their long-term returns. Or to put it another way, stocks that possess certain key factors that historically have been associated with superior returns have a strong likelihood of future outperformance. Accordingly, we use this framework to craft stock investment strategies that have a high likelihood of outperforming the market due to their significant factor advantages.
We start by using internally created research and third-party data to identify certain objective factors that historically have been associated with superior stock performance. These factors can be broadly categorized as being based on a stock’s value, quality, volatility and price momentum.
Once we have identified the key factors associated with stock outperformance, we use them as a framework to create our stock investment strategies. These strategies are then implemented based on the following process.
Identify Stock Universe
Our strategy implementation process begins with identifying the applicable stock universe from which we select the stocks with the most favorable prospects. Each stock universe that we build takes into account certain key requirements such as a stock’s size, liquidity and location of exchange.
Apply Initial Factor Screen
Within the applicable stock universe, we apply our factor-based models to remove from consideration any stock whose factor profile suggests poor future returns. For example, at this stage, depending on the specific strategy, we look to exclude any company that may be overvalued or has exhibited poor financial and/or operating performance or excessive historical price volatility. Our goal here is to avoid bad companies whose stock may be in jeopardy.
Stock Selection
After we have identified those stocks with the most favorable factor profiles, we then rank them based on one or more individual factors such as the stock's valuation, quality, price momentum and/or historical price volatility. Depending on the specific strategy, those stocks with the best valuation, quality, price momentum and/or low volatility factor characteristics are then selected for inclusion in the portfolio, subject to a maximum sector exposure rule. Our goal here is to identify and select those stocks that have the highest probability of future outperformance.
Portfolio Construction
Depending on the specific strategy, the selected portfolio stocks are then either equally weighted, market cap weighted, fundamentally weighted or weighted based on their inverse-volatility. Each portfolio is also remodeled and rebalanced at least annually.
To reduce overall portfolio risk, we adopt the following three principles. First, all of our quantitative stock investment strategies include defensive factors such as investing in high quality stocks that also possess low-to-moderate historical price volatility. Second, our stock index trend-following strategies use proprietary trend-following hedges as a portfolio overlay. These tactical hedges are designed to reduce portfolio risk by moving all or a portion of the portfolio into defensive cash or fixed income investments when the current market environment suggests that the risk of owning stocks is high and keep the portfolio fully invested in the stock market when the risk of owning stocks is moderate to low. Lastly, we frequently combine various individual strategies into one portfolio in order to enhance overall diversification. Consequently, by (1) incorporating quality and low volatility defensive factors into our stock selection models, (2) applying custom tactical, trend-following hedges as an overlay to passive stock index investments and (3) combining multiple individual strategies into one portfolio, we are able to reduce portfolio risk and provide our clients with downside protection in the event of a major market decline.
ABOUT MER CAPITAL
OFFICE LOCATION
1729 King Street
Suite 310
Alexandria, VA 22314
P: 703-740-1765
E: info@mercapitalmanagement.com
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