Systematic investment management refers to rules-based, quantitative approaches for constructing and managing investment portfolios. Instead of relying solely on human judgement, these strategies incorporate statistical models and algorithms to guide investment decisions. This article provides an overview of some key concepts and latest developments in systematic investing, particularly factor-based portfolio construction and risk budgeting allocation methods.
Factor models provide a systematic framework for capturing investment returns
Factor models identify stock characteristics or ‘factors’ that are associated with higher returns over the long run. Common factors include value, quality, momentum, volatility etc. Sophisticated factor algorithms can be constructed by examining factor valuations, crowding, dispersion and momentum. BlackRock’s research examines enhancing factor measurements, complementarity between factors and incorporation of ESG metrics into factors. By tilting portfolios towards attractive factors identified through rigorous research, investors can aim to earn risk-adjusted excess returns in a rules-based manner.
Risk budgeting optimizes portfolio construction aligned with investment objectives
While maximizing returns is important, managing risk is critical for long-term success. Risk budgeting techniques explicitly define risk targets for different asset classes and investment strategies. Industry and style risk budgets can be set based on expected contributions to portfolio returns versus volatility. This aligns portfolio construction to match clients’ risk appetites and ensures appropriate diversification. As macroeconomic regimes and factor cycles evolve, risk budget levels across industries and factors can be flexibly adjusted in a systematic framework guided by data and research.
Systematic approaches complement fundamental analysis and human oversight
Quantitative, rules-based techniques serve to enhance the investment process versus replace human portfolio managers entirely. Systematic frameworks for factor research, portfolio optimization and risk monitoring can scale effectively and reduce behavioral biases. But subjective inputs, qualitative insights and timely portfolio adjustments remain imperative. Prudent investment practices require harmonizing systematic investment processes with human expertise, experience and judgement.
In summary, factor models and risk budgeting are at the forefront of innovations in systematic investing. They provide structured, research-driven approaches for maximizing risk-adjusted returns across market cycles. Combining these quantitative techniques with fundamental analysis and qualitative insights leads to more robust portfolio construction and management.