What is systematic investing
In general there are two types of investing or trading: Discretionary and Systematic. In discretionary investing decisions are based on subjective criteria that cannot be quantified in a clear and consistent way. It relies on one’s own experience in the markets, her knowledge of the economy and her subjective view of what is expected from the markets going forward. On the other hand, systematic investing is a way of defining trade goals, risk controls and rules that investment decisions are made in a methodical way.
In the real investment world, one can find a variety of approaches that mix the two extremes. The following table presents a comparison summary between systematic and discretionary investing.
| Systematic | Discretionary | |
| Trade decision is based on | Price flow(typically) | Information flow |
| Style | Objective based on a well defined formulated strategy with a mathematically positive expectation | Subjective based on own (or expert) opinions and/or past experience |
| Forecasting | Not necessary | Necessary |
| Trading rules | Specific | Loose |
| Emotional | No | Yes |
| Risk Management | Specific, from simple to very sophisticated | Loose |
| Profitable when | Probabilistic return provided that positive expectation exists | Predictions/timing are proven correct |
| Advantages | Elimination of human emotions, Precise quantification of risk and return, Objective analysis, Sophistication | Flexibility, big upside potential if forecasts are correct |
| Disadvantages | Overfitting and data snooping (i.e. engineering historical returns) | Big losses due to poor risk management, emotional factor |
There are two important elements in systematic investing:
- One or more trading rules that produce a trading signal to buy or sell one or more assets. This can range from very simple to very complicated. It can be mathematical, statistical or heuristic in nature. The important key is that one can clearly identify (and repeat) the decision process in detail.
- A risk or sizing methodology that allocates capital for a given investment decision produced by the ruleset
Typically, systematic investing is employed as a way to harvest risk premia or risk factors. The promise is that by applying systematic investing in risk factors one can be successfully exposed to alternative sources of risk.
It is important to note that systematic investing can be factor-based but not necessarily (e.g. high frequency, clone strategies, etc).
According to BarcleyHedge as of 2nd Quarter 2018, total assets under management for the hedge fund industry was $3014.3 billion, and the managed futures (systematic funds) industry was $369.5 billion. Note that total assets under management worldwide is around $135 Tr.