Any successful long-term investment approach should follow a repeatable process. A traditional stock picker might have an implicit process starting perhaps with a valuation model, personal interpretation of the current economic climate, and the stage of the economic cycle. Ultimately, stock selection might be a result of whether the investor “likes or dislikes” a particular stock based on the above information – supplemented by their experience, applying soft skills and judgement in personal meetings with management.
Our team’s systematic process, used for the Jupiter Merian fund range, is in many ways similar, with a solid traditional stock picking approach. One can think of it as a “divide and conquer” method to the traditional approach, where each individual step has been first tested for validity and subsequently coded into rules that are systematically followed by the investment team to construct portfolios. There are, however, some important differences between our systematic approach and traditional investing.
No decisions made ‘on the fly’
One of the key fundamental differences is that all criteria in our systematic approach have been decided before the stock picking takes place. No decisions are made “on the fly” and it is therefore a very dispassionate process. All rules are based on solid economic rationale and tested for validity before being put into practice. Once included in the model they are strictly followed, and although our team enhance the model itself, gradually over time, there is no ad hoc ‘tweaking’ of the individual stock picks. In fact, some of the model’s stock picking criteria are specifically designed to take advantage of a typical investor’s behavioural biases (as evidenced in academic literature), such as mispricing’s that occur due to investors’ acting emotionally and often responding sub-optimally to market events.
In our systematic approach every stock pick can be traced back to the underlying reasons/criteria for choosing that stock. Also, when that stock out/under -performs in the future we can attribute the performance to all the criteria that were set out before the stock was picked, as can be seen in the example of Sulzer below, in which its stock price chart is shown along with how our model viewed the stock on various criteria over time. This is why we often refer to our process as a “glass box” as there is full transparency throughout the process, ranging from why exactly a stock has been picked to attributing the performance ex post.
Example : SULZER
Source: Jupiter. Company examples are for illustrative purposes only and are not a recommendation to buy or sell.
How are the systematic investment criteria established?
Each of our investment criterion or rules starts with the basic yet nontrivial question: “Why should this criterion forecast future stock price movement?”. It is for example not sufficient for a stock to be cheap. A stock can be cheap due to mispricing i.e. the market incorrectly pricing the stock – perhaps due to friction in price discovery process. Alternatively, a stock could be “cheap for a reason” and yet holding such a stock might still be rewarded by a risk premium, a reward for holding a risky stock. In most cases the return to value (a systematic approach to buying cheap and selling expensive stocks) is a combination of both above schools of thought.
To find a satisfying answer to the ‘why?’ question above, our team applies scientific techniques and results from economics and statistics. When we design the rules, for example about which stocks will be classed as cheap and which as expensive, all this information is considered. Such an approach is applied to all stock selection criteria in the systematic investment process, including Dynamic valuation, Sustainable growth, Sentiment, Company management and Market dynamics. In fact, this philosophy is applied across all dimensions of the investment process from stock picking, understanding the time variation of stock picking criteria to portfolio construction and risk management.
Our systematic approach uses multiple criteria and usually stocks that are selected for the portfolios score well on more than one of them. Each criterion would have gone through a similar rigorous research process before it is incorporated into the overall model.
Source: Jupiter. For illustrative purposes only.
Treating triumph and disaster the same
Significant time and effort is put into researching, developing and enhancing new rules and criteria, with a wide variety of known and potential scenarios tested and simulated. The philosophy of our team is to be proactive and to try to answer all questions through rigorous research ahead of time, rather than reacting to current events that can cause panic. Through the lens of a specific moment in time even moderate market events can appear catastrophic – at such times humans tend to overreact, yet a dispassionate model can (to paraphrase Kipling) ‘treat triumph and disaster the same’. This is where the trust in a diligent systematic approach, refined over time, can bear fruit, offering human investing with computer help.
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