A potential solution
One compelling solution to the problem is a combination of the systematic and fundamental-macro approach, in the belief that it can deliver the positive attributes of both while ‘hedging out’ the negative ones. A relatively new foray into such an approach of combining fundamental-macro and systematic is in ‘quantamental’ investing, at this stage practiced mainly in equity portfolios.
Fundamental-macro investing at the core
The fundamental-macro approach, based on the insights of experienced investment managers, is by nature, both forward-looking and deeply connected to the changing economic and financial conditions affecting markets. This makes it particularly suitable to spotting dramatic changes in market behaviour. Furthermore, expert fundamental-macro investing harvests risk premia while hedging with risk-averse, defensive positions. This serves as the right antidote, therefore, to the backward-looking traditional systematic approach that lacks in economic intuition.
In mitigating the over-engineering risk of systematic investing, the fundamental-macro approach, again, comes to the rescue. It is generally parsimonious when it comes to the number of variables and simple in terms of the interaction between analytical parts: it has to be, given the inability of the human brain to effectively process such large volume and complexity of information.
Blending systematic investing with fundamental rationale
Unlike traditional systematic investing, a combination or ‘quantamental’ approach can be put together in a unique fashion so as not to require different types of models, thus eliminating the need to make the capital allocation decision between them.
It is worth noting that the evolution proposed here is not the same as making divided allocations between the two approaches of fundamental-macro and systematic investing. It is not also a mishmash of the systematic and discretionary approaches, where the disciplined decision making of the system is tampered with by discretionary considerations. Rather, the unique approach is based on the expert combination of the rigour coming from systematic, and insights coming from the fundamental-macro, where both approaches preserve their full integrity and effectiveness and work as one in perfect synergy.
For example, imagine removing from systematic investing (i) excessive dependency on price moves as a primary indicator of opportunity; or (ii) the tendency to readily exit from losing positions to go to cash when relief may be available through non-correlated risk-averse assets in the portfolio; or (iii) unconsciously foregoing the all-important portfolio balance and increasing risk in the sole pursuit of market direction for gains.
To conclude, the outcome of the evolutionary process described above is a parsimonious and adaptive model that is systematic-quantitative but predicated on solid fundamental-macro thinking. Such an approach should reap the rewards in most environments and market cycles, whilst softening tail risk in crisis periods and also deal effectively with unusual distortions as those introduced by the recent aggressive monetary easing.
Aref Karim is founder, CEO and CIO of QCM, a systematic global macro manager with 20 years’ operating history