Think outside the Black Box

The rise in popularity of quantitative investment strategies, structured products and sophisticated risk management tools, often coined "black box" investing, is creating ever more opportunities for traditional fundamental investors according to Makis Kaketsis, manager of the top-quartile F&C UK Dynamic Fund.

While investment strategies based on technical analysis of stock and market price movements are nothing new, Kaketsis believes that the extent to which such techniques can influence markets on a particular day has increased dramatically in recent years.

"Chartists, who base their investment decisions on technical analysis of price trends and momentum, have long been around, and enhanced index funds have also been a rapidly growing segment of the institutional investment space," said Kaketsis, "but alongside these other sophisticated quant strategies have become more common place, especially with the development of the hedge fund industry and growth in popularity of structured products."

"Quite simply there has been a steady revolution in the nature of market participants over the last decade, away from investors who focus on fundamental factors such as the quality of company management or the credibility of its strategy and in favour of models that are predicated on concepts such as mean reversion and co-integration."

Kaketsis claims that on certain days when markets exhibit heightened volatility, automated trades triggered by model-driven investments "might count for anywhere between a third and half of trading activity – even if there has been no fundamental change in outlook for underlying companies" .

He points out that the volume of technical selling can also be further exacerbated by the prevalence of risk-overlays, including Value at Risk models, on portfolios managed by fundamental investors. Such disciplines may require a manager to cut a position when a stock price or index hits a trigger point.

"Model driven investment techniques, and advanced risk management tools, clearly have an important place in the modern asset management industry and they are here to stay," said Kaketsis, "but the anomalies that can be thrown up by all this technical selling also creates numerous windows of opportunity for those of us who continue to invest on fundamental factors. Opportunistic buying on the back of these types of technically driven market movements is becoming a regular event in my Fund."

"While I am not in the business of trying to predict where the market may go on a short term basis – and in any case my brief is to deliver long term performance - my belief is that overall stocks still look attractive on fundamental grounds, with PE ratios well below their historic peaks, attractive yields and only modest gearing. I therefore believe that jittery markets, which are at least in small part fuelled by adjustments in risk systems and the triggering of automated trading, present buying opportunities for favoured companies. In recent weeks I have added to positions in ICI, Ultra Electronics and Inchcape – each of which is attractive on fundamental grounds."