The Causeway Emerging Markets Equity strategy begins with a liquidity screen for companies which have a daily trading volume of at least $5 million ($USD) in the 25 emerging markets countries in the MSCI EM index. This screen helps the team invest in companies with adequate liquidity, and reduces the universe to approximately 800 stocks.
Next, we create a return forecast for every stock in the universe based on our proprietary multi-factor quantitative alpha model. The model seeks to exploit both bottom-up and top-down sources of alpha. On the bottom-up side, we broadly classify our factors into three groups: value factors, earnings growth factors, and technical/price momentum factors. On the top-down side, we broadly classify our factors into three groups as well: macroeconomic factors, country aggregate factors, and sector aggregate factors. The model is 2/3 bottom-up, 1/3 top down.
Once we have created the return forecasts, we use an optimization tool in order to determine the portfolio weights that will maximize the expected alpha of the portfolio subject to our risk tolerance, as well as the diversification constraints that we employ. The level of risk we are targeting in the portfolio is 4-5% tracking error with respect to the benchmark. The risk model that we use to forecast risk is a proprietary cross-sectional risk model which includes country, sector, currency, and style risk factors. In the optimization, we also constrain the portfolio to take no more than a 2% active exposure versus the benchmark at the country, sector, currency, and stock levels.
The optimization process uses a transaction cost model to ensure that all trade decisions are influenced not only by risk and return forecasts, but also the cost of entering or exiting a position. The model takes into account implicit transaction costs such as market impact as well as explicit transaction costs such as commissions and stamp tax. The strategy is rebalanced when the available return opportunities are sufficient to justify transaction costs. In practice, the strategy rebalances about once a month (with annual turnover of 85%), but we do execute trades in between rebalances in response to stock-specific events like mergers and acquisitions, for instance, where our quantitative model is not as relevant. To assist us with such decisions, we have Causeway’s fundamental analysts, who are organized along global sectors, as a resource.
Client portfolios will consist of anywhere from 70-120 stocks. The typical characteristic of a portfolio is that it will be cheaper than the benchmark on a number of valuation ratios but will have greater earnings growth expectations.