This article was produced in partnership with Macquarie Asset Management.
It used to be that systematic or quantitative investing models were available only to institutional investors, such as super funds. But now, with ETFs helping democratise investing for all, any investor can access sophisticated systematic investment solutions via the stock exchange, helping provide new tools for portfolio construction.
Systematic investing combines data science and human intelligence in a rigorous, repeatable model designed to deliver consistently above-index returns. Importantly, it steers around many of the pitfalls of relying on the style and individual preferences of a “superstar” portfolio manager.
Systematic vs. fundamental investing
When most investors think of active management, they would think of those utilising a fundamental investing approach. This is where you have a team of highly experienced analysts conducting deep research into company fundamentals, such as its balance sheet and the quality of its management team, to determine the intrinsic value of a stock. They make buy or sell decisions based on the prevailing share price compared to their assessment of its intrinsic value.
Different investment styles work better or worse at different times. For example, when the market is in a growth regime, fundamental managers with a growth bias will naturally outperform. But when that changes and investors start to focus on different company characteristics – for example, value, or future earnings stability – growth fund managers could take a hit.
While a well-informed investor or adviser can apply the principles of fundamental investing to their own portfolios, it is far more difficult to manage a quantitative investment process. A key difference between the styles of investing is that a fundamental analyst will have great knowledge depth of a few companies whereas systematic investing uses data to access a great breadth of information across a large number of companies to drive investment opportunities.
A systematic process sifts through vast volumes of company and economic data, ranging from the potential impact of geopolitical tensions to the tone of the language used in company announcements or investor briefings.
During periods of market volatility, systematic investing can be a useful tool as it is designed to deliver consistently, irrespective of market conditions. The model is built to adapt as it learns, evolving its investment thesis and adjusting the conviction continuously from both success and failures as the market unfolds. The signals in the model effectively define an investment multiverse, where a multitude of possible regimes have been stress-tested even before they happen.
Systematic, but not passive
It’s important to also distinguish between systematic and passive investing, because they are, like the difference between fundamental and systematic investing, not the one and the same.
Generally, passive investments are cheaper than actively managed portfolios, but there is a trade-off, as a passive fund only aims to give investors index returns before fees, not to exceed it, and therefore the investor is missing out on the potential value added by an active manager.
Unlike passive strategies, while Macquarie’s systematic investment process is index-aware, the primary goal to outperform the index after costs through a data-driven approach. Systematically managed ETFs are actively managed to optimise for growth and to deliver the potential for above-benchmark returns, while often at a lower cost than fundamental actively managed portfolios.
A systematic approach continually analyses a market to find new ways to identify attractive stock characteristics, which it distils into a set of specific signals. In Macquarie Systematic Investments’ case, there are currently 60-70 signals in the set, which are all applied to the ASX 300 stocks and to around 1400 stocks around the world.
That’s effectively every stock in the relevant investible universe that Macquarie’s active ETFs continually assess for the most-robust and least-correlated sources of return.
Something for everyone
There’s something for everyone in a systematic approach to investing, not only the institutions, such as super funds and sovereign wealth funds, which currently rely heavily on this type of investing.
For example, investors with core exposure to Australian equities, can now use systematic active ETFs as an effective way to diversify beyond local markets into global equities, whilst also seeking to add alpha to that part of the portfolio.
Younger investors are also already showing a preference for ETFs to help build their wealth, attracted by ease of access and the potential to compound returns over the long term, and now with access to systematic investments in an ETF wrapper, they have more options of choice.
This approach can also suit model portfolios across the client spectrum. Typically, advisers use low-cost passive funds at the core of a portfolio to keep costs down, and then allocate to high conviction and higher-cost active managers via satellite exposures.
But with systematic investing, investors now have the ability to access potential alpha at the core of their portfolio, meaning they can have alpha generating tools across all parts of the portfolio.
Blair Hannon is Macquarie Asset Management’s ETF strategist.
