Benefits of Systematic Investing Approach

MeritorQ being a quant or systematic investment product, we frequently get asked on the benefits of quantitative investing. Whilst both the discretionary and quantitative approaches to investing rely on information for making investment decisions, they differ in the way they access and leverage information in terms of their information sources, information processing, and implementation.

In particular, we highlight two advantages of the quantitative approach which are:
a. The breadth of analysis; and
b. Reduced possibility of succumbing to biases.

Breadth of analysis:
The ability to analyze a large investment universe in an efficient manner is an important differentiator for quantitative approach when compared to a discretionary research process which might be limited by the size of the analyst team. Quantitative techniques typically rank companies on different parameters and then select the ones which best fit investment criteria. Any ranking is only useful to the extent that the population over which the comparison is done is large enough. For example, the ranking in any all-India competitive example like IIT JEE would be accurate for gauging someone’s skill in engineering disciplines compared to their class rank in one subject like science. Because quantitative approaches usually employ automated, efficient techniques for calculating different accounting and valuation ratios, having a large number of securities to analyze over leverages their strengths in efficiency apart from making the ranks more meaningful.

Reduced possibility of succumbing to biases:
There are numerous biases that human beings demonstrate when it comes to investing. One of these biases is the human tendency to use information which is more readily available or can berecalled quickly. This, in behavioral finance, is known as the “Availability bias”. In investing, the availability bias manifests (almost daily) in the overreaction to market news. An investor might react negatively to news of a product recall by a company, when in fact, the product recall might not have a large financial impact on the company. On the flipside, a company which is rather tight-lipped but is fundamentally sound might never get the attention it deserves. This bias might have detrimental impact particularly during portfolio selection.

While analyzing in a consistent, efficient manner over many securities in an unbiased manner are advantages of systematic investing, it is important to note that some key disadvantages to this approach as well:
1) Quantitative modelling that is overly dependent on past relationships, and
2) Excessive rigidity in rules as market regimes shift for example, sector leadership usually changes when markets correct. The 1998-2000 bull market was largely driven by tech stocks which changed to infrastructure companies during 2003-2008 and then to consumers and financials post 2008.

We believe that regular rebalancing in MeritorQ partially addresses the risk associated with point 1; we refresh the portfolio based on the stated rules once every six months.

For point 2, as we have already highlighted, the rules in MeritorQ will evolve based on our research and we will continue to enhance the rules if we find better approaches or if the existing rules are not giving us the expected outcome. However, any revisions to existing rules will be objectively and thoroughly validated whilst ensuring adherence to investment objectives.

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