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How Systematic is Your Systematic Fund Manager?

Is it possible to determine whether a systematic fund makes discretionary transactions based on technical or fundamental analysis? It may be possible, but considerable effort is required.

Numerous funds claim to be completely systematic by employing “algorithms” for market timing. This is primarily included in marketing materials to reassure investors that decisions are as objective as an algorithm can make them.

Is it possible to determine whether a fund manager follows the algorithms or occasionally intervenes based on technical or fundamental analysis?

Why is it important to know? Systematic trading is expected to provide diversification and convexity, as well as a low correlation to capital markets. For example, due to a high payoff ratio, systematic trend-following exhibits the same behavior as a long option position: large gains and small losses. For this reason, this style is utilized to provide diversification. If a fund is not genuinely systematic, these benefits may be lost, and investors may not receive the convexity for which they are paying.

This is a difficult problem. 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 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 on social media or blogs talking about fundamentals like interest rates, inflation, GDP, etc. Fundamental variables may be taken into account in algorithmic trading. Although talking about economic conditions does not necessarily imply interference with algorithms, it could nevertheless be a signal that could 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 a few references to fundamentals in years. This is a 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 be back-adjusted, 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. Finding answers is difficult when there is limited access to information. Even when the information is available, it is not always easy to get the answers.

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