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How Systematic is Your Systematic Fund Manager?

Is there any way to know whether a systematic fund is executing discretionary trades based on technical and/or fundamental analysis? It may be possible but it requires some work.

Many funds claim to be fully systematic by relying on “algorithms” for timing the markets. The main reason this is included in the marketing materials is for ensuring investors that decisions are not subjective but as objective as an algorithm can be.

Is there any way of knowing whether a fund manager actually follows the algorithms or occasionally interferes based on technical or fundamental views?

Why is it important to know? Systematic trading is supposed to offer low correlation to capital markets and provide diversification and convexity. Especially systematic trend-following has the same behavior as a long option position due to large payoff ratio: large gains and small losses. For this reason this style is used for diversification. In case a systematic fund is not truly systematic, these advantages may be lost and the investor does not get the convexity is paying for.

Is there a procedure to determine the probability that a given performance was not achieved by a systematic trading algorithm?

This is a difficult problem. In order to even start, all the fund transactions must be available and then an algorithm must be used to determine whether they fit the trading style described in the marketing materials. This is rarely possible.

For example, if the fund is using trend-following or momentum, then obviously intraday trades could raise some eyebrows. But this is an extreme case. How about investing in stocks or assets that do not fit any accepted definitions of a momentum market? This is another more realistic signal that something may be wrong.

Another indication that a fund is not fully systematic but relies on discretionary trading is when the fund managers spend a lot of time in social media or blogs talking about fundamentals: interest rates, inflation, GDP, etc. Nothing wrong about that in principle and systematic trading based on algorithms may be taking into account fundamental variables but in an automatic way. Although talking about economic conditions does not necessarily imply interference with algorithms, it could be nevertheless a signal that could actually occur at some point especially when there are no references to systematic trading but only to fundamentals.

A fully systematic fund manager I know from social media has made only few reference to fundamentals in years. This is strong indication to me that the fund is truly systematic and although there may be periods when the algos are turned off due to high market risk, nevertheless when they are active the manager is not fiddling with the signals.

Backtests of historical performance although they are based on algorithms can also include, or back-adjusted, for discretionary decisions and signals that would not otherwise have been triggered by an algorithm. For example, by adding statements like:

If date = date_of_entry then buy TSLA
If date = date_of_exit then exit TSLA

In effect then, backtests may conceal discretionary decisions, or even post hoc adjustments, quite easily and backtest results do not necessarily mean the process is systematic. There is no way of knowing without looking at the code carefully.

The objective of this article was to raise awareness that what appears systematic may not actually be. Finding answers is difficult when there is limited access to information. Even when the information is available, it is not easy to get the answers.

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