Basic Summaries on Systematic Value

Systematic Value I: Macro Information Efficiency

A Practical Overview


Information efficiency of an investment manager helps individual returns. Information efficiency of the overall market helps the economy, because market prices guide decisions of companies, governments and households. Qualified macro research is expensive; improving its productivity and translating it into factors for trading strategies is a major source of systematic value. A useful structure for such factors is to divide them into three areas:  [i] fundamental valuation gaps, [ii] implicit subsidies, and [iii] setback risks to fundamentally sensible investment principles. Read more

Fundamental Value

Fundamental Value

The difference between market price and fundamental value estimate is one type of “valuation gap” indicator. It is arguably the most challenging approach, since it must encompass all important relevant information simultaneously and requires both financial and macroeconomic modeling skills. Popular valuation ratios, such as equity earnings yields or real effective exchange rates, can form the basis of a valuation gap, but what is critical is their relation to a plausible theoretical value that accords with the economic environment. Read more.

Macro Trends


Macroeconomic trends are price factors for virtually all traded securities. Hence, changes to expectations of these trends are classic market movers, in particular if their long-term prospects are not “anchored”. Importantly, the influence of unanticipated economic changes is more dominant over longer horizons than is visible in day-to-day fluctuations. In many cases the direction of the impact of medium-term economic change is straightforward and intuitive enough for non-economists. Even information on the state of economic uncertainty can provide valuable information for macro trading strategies, as it affects both volatility and direction of market prices and helps to detect periods of complacency and panic.
As a consequence, applying best practices to create macro trend indicators has great value. There are three major sources of information: economic data, financial market data and expert judgment. Since the range of available indicators is vast one must condense them into a manageable set through plausible theoretical models and statistical estimation methods. Read more.

Implicit Subsidies


We define implicit subsidy as a premium that is paid to financial investors by other market participants through significant transactions or commitments for reasons other than conventional risk-return optimization. Implicit subsidies are more like fees for services than compensation for standard financial risk. Detecting and receiving such subsidies creates risk-adjusted value. Implicit subsidies are paid in all major markets. Receiving them often comes with risks of crowded positioning and recurrent setbacks. Read more.

Mitigating Setback Risk


We define setback risk as a gap between downside and upside risk of an asset or a trade that is unrelated to its fundamental value proposition. It arises from the market’s “internal dynamics” – as opposed to changes in fundamental value – and is a handicap for valid but popular trading strategies. Setback risk consists of two components: positioning and exit probability. Positioning refers to the “crowdedness” of a trade and indicates the potential size of a setback. Exit probability refers to the vulnerability of positions and indicates the likelihood of liquidations.  Read more.

Systematic Value II: Price Distortions

Trading Strategies Based on Price Distortions


Price distortion-based strategies are trading rules that look for apparent price-value gaps. They require consistent monitoring, flexibility, privileged market access and superior financial product knowledge rather than a great information advantage. Price distortions arise from inefficient flows and prevail as long as a sizable share of market participants is either unwilling or unable to respond to obvious dislocations. Their root causes can be risk management conventions, liquidity concerns, mechanical trading rules and government interventions. Read more.

Systematic Value III: Systemic Risk Management

Generating Value Through Managing Systemic Risk


The research and management of systemic risk is critical for the long-term performance of investment managers. Portfolio value changes during crises are often extreme and adverse to many sensible trading strategies. It is hard to predict crises. Yet it is possible to judge systemic vulnerability once crisis-like dynamics get underway. This may provide opportunities to liquidity early or to “sit out” market turmoil. This requires preparation of crisis strategies, a realistic calibration of tail risk and an active exchange of market risk information across investment managers. Read more.