Systematic active investing – combining active insights with systematic discipline

Key takeaways

• Systematic active is an active approach to investing that follows a rules-based approach aiming to generate outperformance.
• Although these funds can leverage discretionary analyst input, their construction means deviation from benchmark returns is typically modest, aiming for more consistent sources of return.
• These strategies aim to offer transparency and consistency of sources of active returns.

Should an investor go active or passive? Historically, investors often felt they had to choose between the alpha potential of active management and the discipline associated with passive investing.

Active investing meant giving a fund manager discretion to use their experience and judgement to try to identify hidden value or future growth. Passive investing meant attempting to replicate a target market with as little tracking error as possible.

Today, approaches such as systematic active aim to bridge that divide.

In this article we’ll explore systematic active – an approach that sits squarely in the middle of the spectrum, aiming to combine some of the core advantages of both active and passive.

Discretionary active and systematic active compared 

Just like active – or perhaps more accurately “discretionary” – funds, systematic active strategies aim to generate returns above those of their relevant investment universe. But the way they approach this is different from a traditional discretionary fund.

In a traditional active fund, a fund manager or manager team has discretion over which securities to buy and sell. While the manager often receives extensive information from a large research team, and their decisions can be framed by robust processes and guidelines, their discretion is a key part of the decision making.

Systematic active strategies, in contrast, use predefined rules to translate investment insights into portfolio decisions. This creates a more systematic and repeatable investment process while retaining the objective of generating excess returns by tilting the fund towards specific investment attributes.

These approaches are not mutually exclusive. Increasingly, we have seen discretionary managers complement their process with quantitative aspects, as well as passive strategies that aim to correct for potential inefficiencies in the construction of traditional indices.

Combining the benefits of active and passive 

A useful way to think about systematic active investing is as the combination of active insights and systematic implementation. Investment views may come from a range of sources, including research, quantitative analysis or market signals, but portfolio construction is governed by a disciplined framework designed to maintain consistency and risk control.

The inputs fed into these rule-based frameworks can be diverse and can include ‘truly’ active security research that combines quantitative data interpretation with human qualitative analysis.

But the way these funds are constructed means they nonetheless have some broad similarities with index funds – they are usually competitively priced and offer diversification* as a result of their exposure to a large number of securities. Views are expressed through hundreds of small, incremental positions rather than a handful of concentrated bets. The aim is to diversify sources of active return while maintaining a high degree of risk control.

While systematic active strategies go beyond straightforward market replication in pursuit of outperformance, risk can be managed within defined parameters, meaning deviation from the benchmark is relatively modest. Within fixed income systematic active strategies, for example, duration, sector and credit exposures can closely align with the index, meaning any excess returns come largely from bond selection alone.

Adding behavioural discipline to active insight 

Discretionary active portfolio managers are typically supported by research teams, structured processes and investment guidelines. Even so, no decision-maker is completely immune to behavioural influences. Overconfidence can make a view appear more certain than the evidence supports; confirmation bias and anchoring can make it harder to reassess an existing thesis; and recency bias can place too much weight on the latest market developments. Loss aversion may also contribute to the tendency to retain an underperforming position for too long or realise a gain too quickly.

These are not criticisms of discretionary investing, but well-documented features of decision-making that can affect investors regardless of their expertise or experience.

Systematic active investing can help moderate these effects by determining in advance how investment insights will be translated into portfolio positions. Predefined portfolio-construction rules can apply the same criteria consistently across securities, while transparent position-sizing, diversification and risk constraints can limit the influence of any single conviction.

Rules governing monitoring, rebalancing and exits can also make it easier to respond consistently when markets move, rather than allowing the treatment of a position to depend on how gains or losses feel at the time. This does not eliminate behavioural risk, but it can make implementation more repeatable, observable and open to review.

Crucially, this need not mean choosing between judgement and discipline. Research and qualitative assessment can still provide forward-looking insights and context, while the systematic framework determines how those insights are sized, diversified and monitored within the wider portfolio.

In this sense, discretionary and systematic approaches can be complementary: one contributes investment insight and adaptability; the other aims to provide consistency, transparency and risk control in how those views are expressed.

*It should be noted that diversification is no guarantee against a loss in a declining market.