Hedge Fund Battle: Discretionary vs Systematic Investing

Man versus machine

November 2020. Reading Time: 10 Minutes. Author: Karl Rogers & Nicolas Rabener.

SUMMARY

  • Given alternative data, machine learning, and AI advances, systematic should beat discretionary investing
  • However, the performance of systematic and discretionary equity market neutral hedge funds has largely been the same since 2009
  • Both were also correlated to the stock market, offered low returns, and featured no performance consistency

INTRODUCTION

Anyone who has watched the hit TV show ‘Billions’ will have noticed that the hedge fund billionaire Bobby Axelrod and his former lieutenant, and occasional nemesis, Taylor Mason have totally different trading styles. Bobby, although mathematically gifted, is a discretionary trader that makes investment decisions on the fly based on receiving new information on stocks from his analysts and network of colorful relationships. In contrast, Taylor is a traditional quant who believes in systematic trading.

For a quant, discretionary decisions are anathema and it is all about scientific research, data, coding, and following the model. While discretionary investing has not really changed significantly over the last few decades, the opportunity set for quants has improved dramatically. Computing power and data have grown exponentially. And then there is alternative data, machine learning, and artificial intelligence that have taken the headlines of industry webinars and conferences.

It is not difficult to view quants and systematic approaches to investing as vastly superior to old school discretionary investing. The latter can be seen as just another source of alpha to be exploited, similar to the retail crowd. In the battle between man versus machine, the latter should clearly dominate in this technology-driven age (read Quant Strategies: Theory vs Reality).

But do they?

In this short research note, we will compare the performance of discretionary versus systematic hedge funds.

DISCRETIONARY VERSUS SYSTEMATIC EQUITY MARKET NEUTRAL HEDGE FUNDS

We are using a proprietary data set of equity market neutral hedge funds that are classified as either discretionary or systemat