I was intrigued to see the following Article, badly written, but a thought provoking read nonetheless, on the ongoing rise of the use of Systematically driven Investment Portfolios as opposed to the traditional “Bottom Up” “Top Down” Fundamental approach.

First of all let’s be clear where I stand. My arguments are not so shallow as to be “fee based”. After all, what’s the point in saving a 1% Management fee if you lose 35%+ of your Net worth.
No. Both disciplines need to stand or fall on their own merits. The benefits of the Systematic approach are that it is far more easy to prove or disprove performance over time
Back in the late 80s I started to “code” myself. I thought I’m a reasonably bright lad with a sound mathematical and problem solving mindset. I was surrounded by “Equity gamblers” who always wanted to buy the next dip, the next get rich stock or Utility privatisation and who only needed the Share certificate as deposit for a loan to “Stag”. Can you imagine?

I traded in very dull but safer UK Gilts. But I learned how to calculate GRY from first principles, understand the Net Present Value of money, understand complex derivatives, and other drivers of financial instruments. As a Maths Geek, I could see very quickly the power of compounding and the importance of comparing to a risk free return.

I worked through a 5yr period when Interest rates rose from 8% to 15% (and remained there for 2 yrs!!), hit 17% for one day on the ERM Exit and, have, been falling (almost) ever since. Government Bonds (Gilts) had Coupons ranging from 14 1/2% 1998, 11 3/4% 2003/2007, and Convertible 10% 1991 and un-dated Consols 2 1/2s with interesting names like “Big Greeks- 13% 2000” or “Little Greeks 9% 2000”. These were tongue in cheek references for a rather infamous hair colouring called “Grecian 2000”.I digress but I was actually “pleased” when these gamblers got “burnt” in an “Equity Crash” happy in the knowledge that (subject to a default) my boring Bonds would be redeemed at 100 and achieve my Gross Redemption yield.

A Mad Scientist?

My venture into Systematic coding, therefore, could potential break new ground. I would use a “null Hypothesis”. I would set out and try to prove that my code didn’t work. Therefore, “by exception” if it worked, …..it was therefore, statistically, infallable. Fantastic……….. Like a mad scientist, my heart raced when I imagined finding the perfect combination set of technical indicators that produced amazing results. I could apply them to any instrument and turn “Silver into Gold”…..without alchemy! The future was mine. And still surrounded by gamblers. Then came the “back test-hangover” The realisation that signals that appeared to have happened…..didn’t actually occur in real time. Some signals had come on and then mysteriously disappeared? Why were my real trading results NOT the same as the machine told me. Furthermore in a strongly trending market my results looked amazing only to suffer continuous “bleeding” in sideways markets.The bitter pill that I had to swallow was that I proved that I, without knowing it’ was “Curve fitting”. Some of my coding had inherent “forward looking bias”.This was my “1990 Eureka” moment. This was that my “Exit Signals” and for Capital Growth and Preservation was far more important than my “Entry Signals”.

Therein lies my problem with many Asset managers. They are far too momentum led and use too many variables that cannot be back tested and most importantly they don’t EXIT well. Its not in their interest to forgo future fees and say “Here’s Your Money back”. They are crippled with the same inability, for the most part, of going 100% Cash. Many have forgotten, either out of greed or stupidity, that if £100 falls to £50 that is -50% but it takes a rise of double that ie: +100% for that £50 to get back to the original £100. I remain aghast that it takes a bear market in Equities to expose poor Advisor recommendations and or under performing Fund Managers. The chasm between Absolute Trading and Pension Fund Management are enormous and do require very different approaches whether Systematic or otherwise. The Regulatory framework plays a very important part.

Regulation

Just as 80s required “Big Bang” to challenge the imperfections of “Dual Capacity”, Regulatory change has been necessary to improve Financial Services and protect the Public. I welcome the majority of recent changes surrounding RDR and to obligate Fund Managers to only provide “fit for purpose” recommendations for their Client. I welcome the new transparency of IFA’s and Fund Managers fees noting that fees haven’t really fallen in line with interest rates. The pre qualification of risk appetite is a key element of the Fund vehicle recommendation process.

The Landscape will continue to change. I hope that some of the more traditional Fund Managers will continue to explore other avenues to assist matching investors goals and retirement objectives, and maybe, just maybe turn an eye to the benefits of a Systematic approach.

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Gerry O'Neill
Gerry O'Neill
Gerry has extensive experience in Portfolio management and trading roles. Passionate about systematic trading and evidenced based investment strategies he cuts through the "inefficient subjectivity" upheld by many market Commentators and provides you with "evidence" for you to consider. Use the Sinergi dashboards and powerful "associative search" functionality to get to the information that is important to you and your business.