Systematic versus discretionary asset management

Systematic versus discretionary asset management

Behind every investment fund lies a way of making decisions. Broadly speaking there are two approaches, with many hybrids in practice. In discretionary management the manager takes each decision on the basis of personal judgement and experience, case by case. In systematic management the rules are fixed in advance and executed consistently, whatever the mood of the moment. The difference sounds technical, yet it largely determines how a fund behaves when markets become stressful.

Discretionary: the manager’s judgement

The strength of discretionary management is flexibility. An experienced manager can weigh circumstances no model has ever seen and can act on nuance, context and market feel. This way of working was the norm in asset management for a long time and remains widespread. The same reliance on judgement is also its weakness. People are susceptible to emotion: fear can invite selling near the bottom, greed can invite holding on too long. Decisions are moreover hard to verify afterwards, because it is rarely clear whether a trade followed policy or intuition. Consistency is not guaranteed either; the same situation may lead to a different decision on Monday than on Friday.

Systematic: rules fixed in advance

A systematic manager works the other way around. The rules that determine when to buy, hold or reduce are laid down beforehand and then executed consistently. That brings three advantages. Consistency: the same input leads to the same decision, week after week. Testability: because the rules are explicit, they can be examined, evaluated and improved, and they can be explained to investors. And no mood of the day: news, market sentiment and emotion do not directly determine the individual decision. Advocates point out that this discipline matters most when markets turn turbulent, because that is when human judgement comes under the greatest pressure.

The honest downside

A system is only as good as its rules. Rules built on flawed assumptions are executed with the same discipline as sound ones. Markets change as well: liquidity, regulation and the behaviour of participants shift over time, so rules require maintenance. A rule that functions well in a calm market can play out differently in a panicked one. Automation can moreover create a false sense of security; whoever never re-examines a system discovers its flaws only once they cost money. Systematic management therefore demands ongoing human oversight.

The hybrid reality

Fully human or fully mechanical management hardly exists in practice. A systematic fund also rests on human responsibility: people design the rules, set the risk limits, monitor execution and decide when a rule deserves revision. The essential difference lies in the moment at which judgement is exercised. The discretionary manager judges during the ride, at every single decision. The systematic manager fixes that judgement beforehand and then no longer lets execution depend on the emotion of the moment.

The question investors can ask

For anyone assessing a fund, the style itself is only half the story. What matters more is whether the style is genuinely practised. A systematic manager can be asked how the rules were designed, who monitors them and when they are revised. A discretionary manager can be asked how emotion is kept out of decisions and how those decisions are evaluated afterwards. Both styles have serious practitioners; the difference lies in the discipline of execution.

Callisto Capital’s choice

Callisto Capital has chosen the systematic school: the judgement is made beforehand, the execution sits with the model.

Callisto Capital is a Dutch fund for joint account; its manager is registered with the AFM under the AIFMD-light regime and is not subject to ongoing supervision. Participation is open from an investment of 100,000 euro. This article is for information only and does not constitute investment advice.