Systematic investment strategies exploit specific market inefficiencies – with clear rules, data and proven factors such as value, quality, sentiment and momentum.
If the capital markets were fully efficient, securities would be correctly valued at all times. The price would reflect all available information: fundamental data and future potential of a company, market sentiment, supply and demand as well as economic and sector-specific influencing factors.
But the reality is different: the market is not fully efficient and securities are therefore undervalued or overvalued. Such temporary mispricing is partly due to the fact that new information, such as company news, is not processed simultaneously and in full by all market participants. Excessive price movements can also be caused by emotional rather than rational investment decisions. A systematic investment approach targets such market inefficiencies and uses them to identify potential returns.
Rational investment decisions
A systematic investment approach to constructing a portfolio takes into account a combination of selected factors, such as valuation, quality and market sentiment.
The advantages over investment decisions that are influenced by many subjective factors are obvious. These include the transparency and reproducibility of a strategy, which can be specifically refined or passed on. This significantly reduces the dependence on individual members of an investment team. The investment approach is also quite easy to adapt to new markets or a changing environment.
Factor-based investing
When selecting equities, a number of factors should be used that are based on proven market anomalies and achieve a solid long-term performance. Frequently used factors include:
- Value: attractive valuation
- Quality: high company quality with stable profits and low debt
- Sentiment: positive market sentiment, optimistic analysts revising earnings and price targets upwards
- Momentum: good price performance in the recent past
Mathematical models and algorithms select equities based on these factors. Quantitative models are highly efficient because they can analyse large amounts of data, react impartially to changes in the market and minimise subjective influences.
Return potential of small and mid caps
Companies are analysed using predefined factors. This makes it possible to identify the most attractive ones. Accordingly, a portfolio should include, for example, companies that have high growth potential, are fairly valued and for which the market is optimistic. The right combination of factors is critical to the success of the portfolio, as they can balance each other out in different market phases. They also react at different speeds. Value and quality tend to change slowly and are based on fundamental economic aspects. Sentiment and momentum are more price-based and reflect the market situation.
The current market environment is attractive for equities of Swiss small and mid caps, as they are fairly valued compared with large companies and there is potential to catch up after a few years of weaker performance. While the share prices of smaller companies are more volatile and therefore often involve greater risks, higher returns can compensate for these risks in the long term. Mid-cap and small-cap equities are often covered less intensively by analysts than large caps. This can lead to inefficient valuations. Nevertheless, such inputs are valuable as they can be further processed in a targeted manner using quantitative models.
Swiss Life Asset Managers is a leading asset manager and provider of equity funds – assuming strategic responsibility and ensuring sustainable performance.
