Systematic investing has become increasingly popular among investors recently. It refers to rules-based, algorithmic approaches to invest in financial markets. By following a defined, disciplined process, systematic strategies aim to efficiently capture risk premiums and diversification benefits. In this article, we will go through concrete examples of systematic investing strategies, their implementation methods, as well as pros and cons. There are abundant applications of systematic strategies, ranging from traditional assets like stocks and bonds to alternative investments. The key principles are diversification, risk management, and discipline in execution.
Quantitative equity strategies combine factors like value, momentum and quality
A common example is quantitative equity strategies, which select stocks by weighting different factors such as value, momentum, quality, low volatility etc. The portfolio manager firstly determines the weighting scheme, then ranks each stock by its factor exposure, and buys the stocks with top rankings. The whole process is rules-based and can be easily programmed. By diversifying across factors, quantitative strategies aim for consistent returns over the long run. On the other hand, relying on backtested rules has its own risks. The models may not work as expected when market regime shifts. Investors need rigorous research and prudent portfolio construction.
Fixed income style investing harvests multiple risk premiums
In fixed income, style investing represents a systematic approach as well. It typically consists of value, momentum, carry and defensive styles. Value aims to identify cheap vs expensive bonds based on yield spread or credit spread. Momentum buys recent outperformers and sells recent underperformers. Carry selects higher yielding assets. Defensive prefers bonds with shorter duration and higher credit quality. Style diversification provides returns uncorrelated to traditional risk factors like term premium. However, the excess returns could be vulnerable if interest rate cycle turns. Investors need dynamic adjustment of style exposures over time.
Risk parity strategies leverage diversification to construct robust portfolios
Risk parity strategies allocate risk budget evenly across various assets. For example, a risk parity portfolio may target equal risk contribution from equity, bonds, commodities and currencies. By leveraging on diversification, the portfolio can achieve high risk-adjusted returns. Moreover, risk is balanced across assets rather than concentrated in equities like traditional 60/40 portfolios. This protects the portfolio during equity market sell-offs. However, leveraging low-volatility assets could pose liquidity risks in crisis situations. Thoughtful overall risk management is essential for long term success.
In summary, systematic investing provides a disciplined approach to diversify across many return sources. But investors still need to understand the underlying economics and manage portfolio risks actively. Systematic strategies should adapt and evolve over market cycles.