Why limit your core portfolio investment to a simple index?

15 May 2024
 

Systematic investing has the potential to deliver above benchmark returns, using a rigorous combination of data science and human intelligence.

It’s hard to imagine life without algorithmic and more recently AI-enabled technology – from finding the fastest driving route to discovering new shows or music to stream based on your individual preferences. Technology can analyse an unfathomable pool of data in nanoseconds, naturally adapt as it learns, and avoid human bias in its logic.

So why wouldn’t you harness this technology for your investment portfolio?

Over the past three decades, systematic (or quantitative) investing has evolved as a disciplined science-driven approach that combines an understanding of mathematics, behavioural science, finance and economics. It brings all these things together in a rigorous, repeatable model with the aim of delivering consistent financial outcomes.

In the past, systematic models were only available to institutional investors like super funds. But now, quantitative investments can be easily accessed via an ETF on a stock exchange.

“With systematic investing, we can have a view on every company in our investible universe, across many different dimensions,” explains Scot Thompson, Co-Head of Macquarie Systematic Investments.

A systematic approach avoids relying on the style or preferences of an individual fund manager. Benjamin Leung, Co-Head of Macquarie Systematic Investments, says that means, for example, that his team wouldn’t take a view on whether the Reserve Bank will raise rates or not.

“Instead, we prepare the model for the eventuality of both of those outcomes and build a naturally adaptive mechanism so it can adjust to opportunities and risks as they emerge,” he says.

Systematic investing can be a useful tool during periods of market volatility because it is designed to help drive consistency across all market conditions. The model effectively defines an investment multiverse, where a multitude of possible regimes have been stress-tested.

“As the environment changes, our model might tilt allocations away from Quality or Growth parameters to focus on Value,” Leung adds. “It’s constantly scanning hundreds of different signals across different characteristics.”

Further than the fundamentals

Most actively managed funds follow a fundamental investing approach. A team of highly experienced analysts conduct deep research into company fundamentals, like its balance sheet and management team calibre, to understand the intrinsic value of a stock.

Systematic investing analyses fundamentals, plus a whole lot more. Our quantitative process sifts through mountains of company and economic data – from the potential impact of geopolitical tensions to the tone of a company’s announcement.

When the market is in a growth regime, fundamental managers with a growth bias will naturally outperform. For example, those invested heavily in the ‘Magnificent Seven’ tech stocks in 2023 were flying high. But when that regime changes and investors start to focus on value and future earnings stability, loss aversion can creep in – and growth fund returns could take a hit.

A well-informed investor or adviser can apply the principles of fundamental investing to their portfolio. But it is substantially more complex to manage quantitative investing on their own. It takes vast amounts of data and computing power: no single analyst can continually scan every company in the MSCI World, and do it well.

“We also take a view on the things we don’t own. That’s quite distinct to a fundamental approach,” adds Leung. “You need to be mindful of the things you might be missing, and that’s why you need a broad view of the investment universe.”

Adjusting through cycles

A systematic model is designed to weather all markets by adapting to market conditions. Rather than sticking to its convictions, it continually learns and improves.

For example, during the unpredictable market volatility of 2020-2023, Macquarie Systematic Investments team’s flagship strategies continued to adapt to changing conditions.

In 2020, when the pandemic hit, Value-oriented stocks tumbled as uncertainty triggered a flight to Quality and resilient business models were in favour. Once COVID-19 vaccines were approved, investors pivoted to more speculative growth stocks. But as inflation spiked and interest rates catapulted upwards, Quality factors such as profitability and low leverage outperformed once more. Finally, in 2023, AI-mania took hold and mega-cap IT stocks dominated global sentiment.

It was a rollercoaster period. Throughout it all, Macquarie’s style-agnostic systematic approach and strategies produced compelling results by harnessing these factor returns, while avoiding major drawdowns and volatility experienced by investment styles dominated by Value, Quality or Growth factors.

“Our model detected an elevating correlation between quality and sentiment throughout the period, and adjusted by expanding exposure to Value. Our investors benefited from this holistic approach – offering a well-balanced portfolio of diversified alpha opportunities, without having to mix and match investment managers with various styles,” says Leung.

How systematic active ETFs work

Macquarie Systematic Investments has spent over 30 years evolving a robust systematic process that has delivered long-term, consistent returns across a range of strategies for leading super funds and institutions, and now bring two active ETFs to the Australian market:

• The Macquarie Core Australian Equity Active ETF (ASX:MQAE) gives investors access to a finely-tuned portfolio of around 100 - 200 ASX shares.
• The Macquarie Core Global Equity Active ETF (ASX:MQEG) comprises around 200 - 500 systematically selected global shares.

The Macquarie Systematic Investments machine is constantly scanning the market with one eye on the future, with inputs continuously being updated and the signals utilised fine-tuned to seek potential trades.

Macquarie’s dedicated in-house quantitative team are continually analysing the market in search of new ways to identify attractive stock characteristics, which are distilled into specific signals. Currently, the signal set is over 60 signals, and all are applied to the 300 ASX stocks and around 1,400 global equities for these active ETFs. That’s effectively every stock in the relevant investible universe for each active ETF, continually assessed for the most robust and least correlated sources of return.

And these unique signals bring to life the systematic process.

“We can build a more balanced fund portfolio with significantly reduced impact from human bias, which has stability, and is risk-aware,” explains Thompson. “We’re very conscious of how many stocks we hold, what their weights are, and what the outcome might be from a risk and exposure point of view.”

“These are actively managed ETFs that might work well as long term core portfolio allocations as they aim to perform consistently over the long term,” explains Blair Hannon, ETF Investment Strategist at Macquarie Asset Management.

“There’s still a role for passive investing at the core, but systematic ETFs give you the potential for better returns. Because we don’t just follow an index, we start with it. And add a systematic process that seeks to enhance returns over index performance.”

Even better, Macquarie Systematic Investments’ new ETFs come with a competitive fee structure.

“Our systematic ETFs have a cost-effective management fee, plus a performance fee only when we beat the index*. That means the long-term goals of the investor and the investment manager are aligned,” says Hannon.

A systematic advantage

Leung says his team has two unique advantages that give them confidence – and perhaps an extra edge – in their quantitative investment process.

“Because our model was developed in Australia, it understands how to deal with a concentrated benchmark like the ASX. That makes us more attuned to subtle changes in other markets – such as tech concentration in the US,” he says.

He says the team also benefits from the support of Macquarie’s global scale, without having to follow a house view. “Our focus is always aligned with our investors’ outcomes.”

Systematic investing has benefits for a broad spectrum of investors. Younger investors already show a preference for ETFs to help build their wealth¹. ETFs with a low fee structure and the potential to generate and compound returns over the long term may work well for them. ETFs can also be used to diversify exposure to global equities with a mix of passive and core active ETFs providing the potential for enhanced returns.

Hannon says this approach can also suit model portfolios for advisers across the client spectrum.

“Typically, you’d use low-cost passive funds at the core, and allocate to high conviction active managers via satellite exposures to keep the overall costs down,” he explains. “But let’s say those core allocations make up 70% of the portfolio. Adding the potential for alpha with a systematic active ETF has the potential to make a big difference to their outcomes.”

Beyond the index

Passive portfolios can only perform as well as the index. If investors' core portfolios rely on passive funds to keep fees low, they could be missing out on the potential to beat the index. We’ve designed our active ETF fee structure to optimise for growth. 

For more information on Macquarie ETFs, including educational materials to support conversations with your clients, please visit our active ETF site here.

Risks

All investments carry risk. Different investments carry different levels of risk, depending on the investment strategy and the underlying investments. Generally, the higher the potential return of an investment, the greater the risk (including the potential for loss and unit price variability over the short term). The risks of investing in this Fund include:

Investment risk: The Fund has exposure to share markets. The risk of an investment in the Fund is higher than an investment in a typical bank account or fixed income investment. Amounts distributed to unitholders may fluctuate, as may the Fund’s unit price, by material amounts over short periods.

Market risk: The investments that the Fund has exposure to are likely to have a broad correlation with share markets in general. Share markets can be volatile and have the potential to fall by large amounts over short periods of time. Poor performance or losses in domestic and/or global share markets are likely to negatively impact the overall performance of the Fund.

Security specific risk: Securities and the companies that issue them are exposed to a range of factors that affect their individual performance. These factors may cause an investment’s return to differ from that of the broader market. The Fund may therefore underperform the market and/or its peers due to its security specific exposures.

Manager risk: There is no guarantee that the Fund will achieve its performance objectives, produce returns that are positive, or compare favourably against its peers, or that the strategies or models used by the Investment Manager will produce favourable outcomes.

More information on the risks of investing in the Fund is contained in the Product Disclosure Statement, which should be considered before deciding to invest in the Fund.

Important information

The Macquarie Core Australian Equity Active ETF and the Macquarie Core Global Equity Active ETF is designed for consumers who: are seeking capital growth and income distribution, are intending to use the Fund as a core component, minor or satellite allocation within a portfolio, have a minimum investment timeframe of five years, have a high or very high risk/return profile for that portion of their investment portfolio, and require the ability to have access to capital within one week of request.

The Target Market Determination (TMD), available at macquarie.com/mam/tmd, includes a description of the class of consumers for whom the Fund is likely to be consistent with their objectives, financial situation and needs.

The Macquarie Core Global Equity Active ETF is a separate class of units in the Macquarie Core Global Equity Fund (ARSN 674 553 201). A separate class of units is not a separate managed investment scheme.