Understanding Systematic Investing for RIAs
Systematic investing is an investment management approach used by portfolio and fund managers. It leverages rigorous use of fact-based financial, economic and other data to drive investment decisions and maximize repeatability and consistency. An increasing number of wealth managers and Registered Investment Advisors (RIAs) are using systematic investing strategies and funds for their client portfolios.
Read on to learn what systematic investing involves and why it’s beneficial for RIAs to use systematic strategies and funds to improve client satisfaction and outcomes.
What Is Systematic Investing?
Systematic fund managers use complex quantitative models and data analysis to determine portfolio risk exposures. The idea is to bring a greater degree of rigor, testing, transparency and consistency to the investment process versus, say, discretionary investing where the reasons for decisions are often difficult to pin down precisely and vary over time and by decision maker.
For example, whereas a discretionary fund depends very much on the ‘who is at the helm at the moment’, a systematic fund depends very much on ‘what is the data telling our models at the moment’.
Benefits of Systematic Investing
Here are some of the chief benefits of investing in systematic funds cited by RIAs in recent surveys:
Reliability & Repeatability – Quantitative methods intensify the use of data and models to reduce reliance on individual biases, preferences and ad-hoc analysis.
Transparency – The mathematical operations and models that power most quantitative methods can be complex, but their outputs are straightforward, transparent, and decisions are easier to communicate.
Capital protection – Quantitative methods can rigorously enforce diversification and capital protection mandates starting from portfolio construction and flowing all the way through to risk exposure management and trading operations.
Risk management – Models can consistently monitor and quantify risks as they emerge and execute appropriate trading to provide enhanced risk management.
Fundamental vs. Systematic Investing
Systematic strategies and funds come in all types and flavors just like discretionary strategies and funds. There are fundamental, global macro, multi-asset, and sector-specific (to name a few) systematic strategies just as there are in the discretionary world.
Another way to think about the benefits of systematic strategies and funds is to compare the systematic approach with the discretionary approach:
Discretionary Investing – In this model, investing is akin to an art. Managers analyze individual investment decisions based on fluctuating factors, often dependent on personal preference, and most, if not all, decisions are subject to varying degrees of emotion and bias making it difficult to tease out exactly why decisions are made as they are.
Systematic Investing – This model tries to make investment decision-making as much of a science as possible. Managers analyze data using models. Little to no attention is paid to the preferences of individual managers as ‘the model’ rules. There is little variation in fund style even as the team of people behind changes over time and style drift tends to be much less of an issue than it is for discretionary investing.
Systematic strategies and funds offer RIAs the consistency and reliability of technology as a way to invest client funds. Such funds can be straightforwardly aligned with client goals and performance can be easily communicated.
Types of Systematic Investment Strategies
As mentioned above, systematic strategies and funds vary widely but some of the most common include:
Single- and Multi-Factor strategies target one or multiple factors (value, volatility, etc.) either primarily or exclusively, often across multiple asset classes.
Multi-Asset strategies specifically seek diversification across asset classes (stocks, bonds, commodities, etc.), either for a specific goal or to balance outcomes across all of them.
Multi-Strategies combine several strategies under a single system, often dividing each fixed contribution or unit purchase into pre-proportioned amounts per each strategy.
Capital Protection and Risk Hedging strategies seek not to eliminate or avoid risks but offset them with relatively low-risk purchases that prioritize equity and/or fixed income.
Risk Parity strategies target a specific amount of risk or market volatility across all fixed contributions and purchases—for example, investments may be capped at 10% volatility.
Momentum strategies focus primarily or exclusively on momentum (assets that are outperforming the market) either within an asset class or across asset classes.
RIAs and wealth managers allocate to systematic strategies as they normally do, in their model portfolios, to achieve their clients’ specific goals and objectives.
Key Components of Systematic Investing
Today, there are many systematic strategies and funds to choose from. Each may have differences that make them apt for specific purposes or situations, but most share the same core characteristics:
Data and Technology – Advanced analytical methods, which may include artificial intelligence or similar advanced statistical methods, are used to develop analytical models for decision-making. Data collection tends to be very large and many data source are real-time.
Model Development and Validation – Quantitative models form the backbone of selecting and sizing risk exposures. Models are continuously updated with new data as they are published by exchanges, national statistical bureaus, and third-party proprietary sources.
Risk Management – Systematic strategies often integrate risk-management functions up front, into the portfolio decision model itself, rather than add it on at the end of the investment process where it would need to remedy poor portfolio decisions after they have already been made.
Given their shared principles and variety of objectives, systematic strategies and funds can be utilized to meet a wide spectrum of investor needs and goals.
Implement Systematic Investing in Your Practice
To get started, seek out a systematic fund manager with a proven track record. Think about the team’s experience, approach to risk management, and overall transparency at your firm of choice.
Rigorous systematic investing is fundamental to the philosophy of Markin Asset Management. To learn more about how it can benefit your practice, get in touch today.