How to Build an Investment Strategy in 2021

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At a high level, a quantitative strategy is a set of filters that are applied to a database so that it selects a number of stocks to invest in. A “good” strategy is one that provides a historically high return, at low risk.

Building a basic investment strategy follows a simple approach:

Step 1 – Universe Selection

We choose stocks from specific countries, markets, industries or size categories (market capitalisation). For example – US, large-cap stocks.

Step 2 – Static Filters

Next, we add our static filters to the remaining stocks. We can choose any metric from any of the high-level factors.

For example, select stocks with a Return on Equity greater than 30% and select with a Price-to-Earnings of less than 5.

At this point we could be down to just 200-300 stocks, depending on how broad the filters are in the previous step.

Step 3 – Ranking

Next, we apply a ranking/order to the remaining stocks. Again, we can pick any metric here. The ranking operator has a big effect on the performance of a strategy as it can be the attribute by which most weight is given.

For example, we can rank our stocks by their descending 6-month price momentum, ie. those with the largest stock price increase over the past 6 months.

Step 4 – Choose Portfolio Size

The number of stocks in a portfolio can also have a big impact on the performance of the portfolio. A more concentrated portfolio of 5-10 stocks will likely produce higher returns but with greater volatility. We usually like a portfolio with 20-25 companies in it.

Et voilà, you have created a quantitative strategy that picks undervalued, high-quality stocks with high momentum.

Check out some of Aikido’s best basic trading strategies here: The Stable Dividend, Factor Blend, and Concentrated Quality

Premium Strategies

Our premium strategies take a slightly different approach to the filtration process. The Aikido Team has been busy innovating on our strategy curation process, and the results are spectacular. We’ve read the research and incorporated new features into our application, based on our findings. Our premium strategies utilise a new stock selection flow which can help reduce risk and improve return.

Sequential Ranking

An issue we discovered during our research is that static filters do not account for certain changes in the economy and therefore changes in the underlying fundamental data of each stock. For example, filtering for stocks with a price/earnings ratio less than 10 gives a very different result now than it did in 2008. We looked for a more dynamic approach to solve this problem. Our premium strategies can now apply a sequential filtering process. This filtering process allows us to build a dynamic factor model using multiple metrics. The sequence by which the metrics are used determines the concentration and exposure of each metric in the final portfolio.

Our new approach allows us to rank and filter stocks multiple times in one strategy. Take for example our Sequential Factor Blend strategy. First, we select the top 100 most efficient stocks, measured by Return on Equity. Then, we take the top 50 of these stocks, ranked by ascending Price / Earnings ratio. Finally, these stocks are ranked by their 3-month price momentum, and the top 10 are chosen. This strategy has an average annual return of 14.62% per year, backtested since 2000.

Trend Follower

We have included a new feature called the Trend Follower. The trend follower is based on research conducted by Gary Antonacci into Dual Momentum. It is an indicator that provides a Buy/Sell signal during the rebalance process, depending on the momentum of the underlying benchmark. An example trend follower would check if the S&P 500 is positive, if so, rebalance as usual, otherwise sell your positions and hold cash. The trend follower greatly reduces volatility as it prevents users from holding stocks during downturns in the market. Take look at a comparison between two premium strategies: Smart Quality & Top Quality and High Momentum. The performance of each is impressive, but the inclusion of the trend follower in the Smart Quality strategy improves the risk-adjusted returns, volatility, and max drawdown for just a small reduction in the average annual return.

These more performant investment strategies are easy to implement and easy to understand. Check them out here.

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