Systematic global equities: Tackling challenging macro environments
With volatility likely to continue, Matus Mrazik explains how a systematic approach can help to weather tough macro and style environments.
With volatility likely to continue, how can a systematic approach help to weather tough macro and style environments? Matus Mrazik, Fund Manager, Systematic Equities, discusses why he and the team take a ‘macro agnostic’ approach to investing, focusing on what they believe they can predict with some statistical degree of certainty.
Recent major events have, unsurprisingly, caused significant market volatility across risk assets. In the last quarter of 2021 global equities struggled, largely driven by a repricing of macro expectations given higher-than-expected inflation numbers. Given that distant cashflows are discounted more heavily than stocks with cheaper valuations, this disproportionately impacted expensive growth stocks. Meanwhile, though commodity markets had already been rising for some time as inflation fears grew, growing geopolitical tensions and the subsequent invasion of Ukraine pushed expectations higher.
In an attempt to manage inflation, several central banks have started to increase interest rates. This follows a prolonged period of very low rates, and loose monetary policy in general, to which the investment world had become accustomed. Given the changing backdrop, this naturally leads investors to ask, how will the new environment affect different investment strategies?
Significant style rotations
In terms of style returns, we have seen some substantial rotations recently. For example, in the fourth quarter of 2021 and the first quarter of 2022 we saw one of the largest rotations on record, as value stocks significantly outperformed growth stocks, with tech names selling off particularly sharply.
The macro interpretation of this event is that growth stocks often have overly optimistic earnings growth forecasts over a long period; as concerns about inflation and central bank rate hikes grew towards the end of last year, these optimistic forecasts became more heavily discounted, as previously cheap borrowing that fuels growth and consumer spending was expected to become more difficult given an impending higher-rate environment.
This outperformance of value coincided with negatively correlated quality and growth styles strongly underperforming, polarising the cross section of stock returns, with “no place to hide”. Strong outperformance of cyclical risk-on value is unusual in a risk-off environment and falling market, highlighting the importance of diversification, given the difficulties in predicting the timing and nature of style rotations.
Furthermore, moving into 2022, as geopolitical tensions started to intensify ahead of the invasion of Ukraine, we saw a reversal of this style rotation, while momentum also exhibited high volatility.
Large style rotations
Source: Jupiter systematic equities team, as at 01/04/2022.
Tackling challenging macro environments
Our global systematic equities strategy is designed to tackle these kinds of challenging environments. We are “macro agnostic”, meaning we do not attempt to predict macroeconomic outcomes or market moves. Instead, we choose to focus on what we can predict with some statistical degree of certainty.
At the core of our strategy is a diversified set of stock selection criteria designed to offer independent or additive information – this is our first line of defence against market uncertainty. Some stock selection criteria are more cyclical by nature, and others are more defensive, though having a core strategic allocation to each allows the rest of the strategy to deviate in a more tactical fashion. Our strategic weighting is based on our conditional downside risk metric.
Different components within our process, while conceptually falling under a top-line stock selection criteria label, are often designed to provide independent information, so the sources of alpha are truly diversified. Some level of diversification across criteria is optimal if a strategy is going to be able to offer the potential for outperformance regardless of the environment.
Answering uncertainty
Source: Jupiter systematic equities team, as at 01/04/2022.
Events in macroeconomics and style moves within equity markets have resulted in a rising risk environment throughout the last two quarters, particularly since the outbreak of war. Conversely, market sentiment has been decreasing, reflecting the worries of the current global backdrop, both in terms of markets and more broadly speaking.
We form forecasts based on our measures of risk environment and market sentiment. We look at current market sentiment and the level of market uncertainty, and then we look at similar periods historically, allowing us to build expectations about how a particular style of investing is likely to perform going forward. One could describe this as a statistical or “machine-learning” model, which estimates a nonlinear surface of expected outcomes, conditional on the current state of the world or environment. It is a simple, intuitive, but powerful way of learning from data.
We use this approach to deviate from the strategic weighting tactically. This gives us an opportunity to react and build a portfolio of optimal stock selection criteria given the information set we have available, and to forecast the aspects that we believe we can forecast. This gives us the luxury of being able to stay macro agnostic.
Source: Jupiter systematic equities team, as at 01/04/2022.
The value of active minds – independent thinking
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