A Powerful Investment Partnership

Key Points

• In the aftermath of Covid-19 the financial regime has changed and is dominated by strong trends such as inflation, reshoring, and supply-chain disruptions, which creates more opportunities and challenges for investors.
• Humans and machines have complementary strengths that we believe can be harnessed to help achieve better investment outcomes in the changing environment.
• In our view, cross-team collaboration between fundamental and systematic investors can enhance decision making.

The aftermath of the 2007-8 global financial crisis was characterized by historically low interest rates and abundant liquidity as central banks stepped in to administer repeated waves of quantitative easing (the process by which central banks purchase government bonds or other financial assets to stimulate economic activity). Financial markets benefitted from this largesse, and mere exposure to beta delivered a handsome return while alpha was left largely unrewarded.

The financial regime has now changed, accelerated by the onset of Covid-19, which saw government spending play a more dominant role as the baton passed from monetary to fiscal policy, fueling a surge in inflation. Dominant themes have emerged which characterize this new regime:

• It looks increasingly clear that a higher level of inflation is here to stay, and central banks have had to row back on their original assertion that inflation would be transitory in nature.
• Reshoring is the order of the day as countries retrench and are less willing to share their intellectual property and collaborate in global initiatives.
• Supply chains are also disrupted, being affected by geopolitical tensions which have resulted in bottlenecks and longer lead times.

In summary, the world is likely to be less efficient than in the aftermath of the financial crisis, and there will be more friction, uncertainty and volatility across different economies. We believe this will give rise to a greater dispersion of returns and a richer set of opportunities, and that there will be a need to increase the breadth of asset classes deployed.

Working in Tandem Towards a Common Investment Aim

There has recently been much excitement around the potential for machines to enhance the human experience and push out traditional boundaries. In a new market regime, is there perhaps an enhanced role for human/machine symbiosis in investment strategies? Undoubtedly there is a need for investors to be nimbler and more flexible than ever. However, the machine does not exist without humans and will only reflect what humans have programmed it to do. In this context, we see the real power of the machine as being its ability to aggregate a large volume of information to produce indicators or matrices that capture the essence of multiple data points.

The machine process creates mathematical rigor around it to create an outcome, expressing what we, as humans, are trying to assess in a more intuitive fashion. It can also help evaluate the level of uncertainty of outcomes and the likelihood that there will be sufficient compensation for the risk taken. The reality, in our view, is that both humans and machines can ‘feed’ one another, each working at different points in time and in different ways, with the aim of achieving a superior outcome. We therefore think it is misleading to think of humans and machines as distinct entities, but rather that we should see them as two parties working in tandem towards a common aim.

Fostering Cross-Team Collaboration

In order to accelerate this cross-fertilization process, the appropriate resources need to be in place. These include employing the right investment professionals, harnessing cognitive diversity and exploiting a flexible mindset. We do not think a siloed approach will work and we favor a horizontal structure with a strong focus on cross-team collaboration and an ability to fine tune the mix of individuals.

There will be times when human insight will have the upper hand. For example, during the post-Covid period, central banks and authorities implemented a backstop to underpin markets, followed by a massive liquidity injection. Quantitative models were unable to react to the sharpness and the severity of the shock, which prevented investors from participating in the asset rebound. Furthermore, the nature of the shock was very different from what had happened historically; it delivered both a supply and a demand shock simultaneously. Models struggled to find the best way to react to such an unusual dynamic. However, the sheer speed and scale with which quantitative techniques are able to operate can provide valuable input for more fundamental approaches.

Supporting Better Decision-Making

We would contend that the current environment is one in which a hybrid approach should thrive. There is a need to be faster and apply risk allocation to a much broader set of decisions, with the ability to integrate portfolio insurance to cushion against a range of uncertain outcomes. The multiplicative effect of unifying systematic and fundamental approaches has ample scope to shine against the backdrop of a new regime and requires a seasoned investment team. The capacity to bring experienced fundamental investors together with experienced systematic investors is a relatively rare approach for asset-management firms that traditionally have tended to promote the attributes of each separately without thinking about the benefits of combining the two.

It is our belief that blending the two approaches to manage portfolios can lead to greater efficiency of decision making and, ultimately, better outcomes. For example, fundamental investors who have access to the output from a systematic team can save considerable time in collating macroeconomic and market data. Furthermore, there are large amounts of money managed using quantitative approaches in the market, and knowing the signals these other investors are using can inform the debate.

Fundamental and Systematic – The Best of Both Worlds

Since our fundamental and systematic investors started working together, our fundamental investors have been able to improve their own models by using the engineering platform of their systematic colleagues. This has allowed greater efficiency to filter through and has given the fundamental investors more time to focus on new ideas. For our systematic investors, having a fundamental team highlighting when trends are about to change can help them de-emphasize certain signals and make them quicker to react to a change in direction. Ultimately, clients will look to benefit from the best combination of tools to inform both approaches.

Markets have expanded, both in terms of size and the number of instruments used, and we are in a new regime that is likely to drive greater volatility. Standing still is not an option for investors confronted with evolving markets and expanded data sources. The market is influenced by both fundamental and systematic investors, and while having both skillsets within an organization is rare, we believe it will be increasingly important to help understand the underlying drivers of markets.

Authors

Dimitri Curtil

Global head of multi-asset solutions

Catherine Doyle

Investment specialist