Tough to beat – rules-based trading strategies

We believe in rules-based trading strategies. Why?

Because rules lead to better trading decisions in highly dynamic and noisy financial markets.

While most quantitative fund managers have a long history of outperforming benchmarks, most discretionary fund managers have a long history of underperforming.

For example, 84.23%* of large cap funds have underperformed the S&P 500 during the past five years.

One reason for underperformance is fees.

Another is poor decision-making as a result of uncertainty.

And yet another is the fact that benchmarks such as the S&P 500 are themselves rules-based trading strategies – and those are tough to beat.

“Diversification is the only free lunch in finance.”

(Harry Markowitz)

As an example, the above chart illustrates the performance of the FIVE Trend Index during various periods of market stress.

Historically, the FIVE Trend Index has been an effective counterweight to equities during volatile times.

The long-term correlation of the FIVE Trend Index to the S&P 500 is around zero – a valuable feature given that “diversification is the only free lunch in finance” (Harry Markowitz).

Fees matter

Investment costs may seem small, but they add up and compound in the same way as returns.

Imagine starting an investment with $100,000 today.

If your investment earns 5% per year with 0% fees, it will be worth $253,000 in 20 years.

However, with 2% annual costs it will only be worth $175,000.

That’s a difference of $78,000 and equivalent to a 44% underperformance solely due to fees.

Every basis point counts!

Good investing isn’t easy, but sticking to a set of rules helps

Humans are prone to suffer from various emotional biases when it comes to investing.

The most common mistakes are overconfidence, loss aversion, performance chasing and over-trading, to name a few.

Avoiding those biases can be a real booster to your long-term investment results.

That’s where rules-based, systematic trading strategies come in. Because those strategies are based on a pre-defined set of rules, discipline and consistency are naturally integrated into the investment process.

Loss-Aversion

For example, research by Kahneman and Tversky shows that losses affect human beings’ emotions twice as much as gains.

This directly impacts human decision making in a bad way: while the average investor typically sells winning positions quickly, losing position are kept in the hope for reaching break-even again.

We eat our own cooking

Munich Re has “skin in the game” as the company invests substantial proprietary capital in FIVE’s investment strategies.

In other words, we eat our own cooking and therefore have the same interests as our investors.