systematic investing: Learn with ETMarkets: A Guide on Systematic Investing; 5 advantages which investors should consider

You can devise strategies for playing better in not-so-normal situations, too, by adopting quant-driven strategies to construct an automated portfolio. This investment approach is termed Systematic Investing.

This article will guide you on what systematic investing is, what are the drawbacks of discretionary investing and how systematic investing overcomes these problems.

What is Systematic Investing?

Systematic investing is an investment approach that uses a rule-based approach for portfolio creation. It uses data-driven insights and advanced computer modeling techniques, in an automated way, that offers many advantages over the traditional approach.

Systematic investing is popularly known as quantitative investing, algorithmic investing, or rule-based investing.


The Problems with Discretionary Investing Approach

Discretionary investing is an old-school investment approach where your fund manager takes all investment decisions on your behalf. It involves looking at qualitative factors like management capability, the strength of a company/sector vis a vis its competitors as well as quantitative factors like financial ratios of a company and price.

But at the end of the day, the decision to invest in a company or not is much more based on subjective factors. Though it has its own advantages, there are some obvious drawbacks to this approach.

● The limited capacity of fund managers

One problem with discretionary investing is the limited capacity of a human being. In such an investment approach, starting from searching for investment avenues, to constructing your portfolio, to delivering returns, all tasks are of your fund manager.

But we all understand that if we can quantify the factors on which we are basing our decisions, then computers can do a much better job than humans.

● Subject to Human bias

Human involvement often brings along human judgment and bias. What is worthless for one person can be of immeasurable worth to others.

Similarly, a stock or fund valuable to you might be ignored by your fund manager because of subjective bias. Every investment decision can significantly impact your portfolio performance, and the fund manager’s incorrect judgment can be a reason for lower-than-expected returns.

● Returns depend on the fund manager’s skill and knowledge

One of the biggest problems with the discretionary investing approach is that your returns are highly dependent on the decision-making as well as research skills, knowledge of financial markets, and experience of fund managers. After all, he is the one who will take your investment decisions. If he lacks proper knowledge, skills, and experience in the market, your portfolio may see a big hit.


How does Systematic Investing overcome these problems?

● Not dependent on one fund manager

With a systematic approach, you are not dependent on the skills, knowledge, and experience of one fund manager. Rather, a team of professional managers works on research to make the best out of your portfolio. As more fund managers work together to construct portfolios and bring their skills and expertise to the table, your portfolio is likely to be constructed in a better way, offering amplified returns.

● Scientific Approach

The systematic investing approach significantly differs from the old-schools approaches to investing. It believes that market prices don’t move in a random way, rather their movements are statistically measurable and predictable. Systematic investing involves high-quality big data, data science, data mining, and scientific testing of investment ideas to make an investment decision.

For instance, before making any of your investment decisions, historical price data may get tested keeping out some markets and periods. Then, the test may be conducted again including those markets and periods which were previously excluded. This way, it helps in minimizing the dangers related to an investment decision.


● Sound Investment Decisions

When the Discretionary investing approach believes in suggesting fundamentally sound investment ideas, systematic investing goes a step above. It involves qualifying sound investment ideas using advanced modeling techniques, and filtering out others. This approach does not ignore human decisions, rather it amplifies them. Moreover, it makes sure that your portfolio is free from human bias.

● Scalability

Systematic investing saves you from concentration risk by constructing well-diversified portfolios including varieties of securities. Automated and quick processing of new information with keeping risk elements in check allows for better implementation of investment strategies.

● Better targeted outcome

With the help of systematic investing, investors can have a much better control over the performance of their portfolio.

These rule-based strategies can help investors optimize portfolios for better risk-return tradeoff.

For example, an investor looking to reduce volatility in his portfolio can consider investing in low-volatility stocks.


Final Thoughts

Investors have been open to investing in many such rule-based strategies, like factors based ETFs and curated basket of stocks. There has been tremendous advances in awareness about these systematic strategies and their benefits in all market conditions.

This bodes well for the future of the investment industry. Investors should ideally allocate a part of their funds to the systematic strategies as then they will be able to take advantages of the scientific rule-based approach.

(The author is Director (Strategy), Estee Advisors)

(Disclaimer: Recommendations, suggestions, views, and opinions given by the experts are their own. These do not represent the views of Economic Times)