For some time now, we have been writing about the rise of volatility, the importance of Federal Reserve (Fed) policy, global growth, and other factors with respect to financial market performance. In this issue of CIO Insights, we thought it appropriate to revisit some key themes about our investment approach itself. Here we explain why we believe a disciplined, systematic, objective process with an explicit risk-management framework is well suited to capturing opportunities, even in volatile markets.
Read Wittman’s full Q2 2016 CIO Insight:
Focus on “Known Knowns” Instead of Market Fluctuations
Objective, Systematic, and Disciplined
Our goal is to implement fundamental insights into our portfolios using a systematic approach. We seek to accomplish this goal by being objective, systematic, and disciplined. Our investment ideas are evaluated objectively using economic reasoning and rigorous empirical validation. These ideas are then implemented systematically in all our portfolios. Discipline may be simply stated as acting consistently with the principle: “Know what you don’t know.”
Emphasis on Consistent Performance
Our disciplined approach to stock selection and portfolio construction is designed to provide consistent, risk-adjusted outperformance in a variety of market conditions. Some of the factors in our model are based on valuation metrics, while others look for growth and momentum indicators. Still others, such as quality factors, capitalize on anomalies that are relatively uncorrelated with value or growth markets. In theory, the diversification effect of having multiple factors should create a less volatile, more consistent source of excess return. We strive for this consistency regardless of economic or market regime—whether markets are volatile or placid, rising or falling.
Risk is a multi-faceted concept with many dimensions. Our solution to managing risk is similarly multi-layered. In the first place, we aim to reduce unintended portfolio concentrations—for example, an unintended bias towards highly leveraged companies.
We also monitor exposures to macroeconomic influences through the lens of an independently developed macro risk model. In addition, in recent years we have made significant investments in a proprietary analytics platform that will serve as the foundation for further enhancements to our risk management practice. These will include rigorous, proprietary risk measurement tools to provide us with nuanced information about fundamental/ macro risks.
Volatility in Perspective
Volatility can be unsettling—big swings in account balances can send us from caviar dreams to visions of a working retirement. But such volatility is characteristic of markets as a whole and in some sense should be understood as par for the financial course. It is better to plan than it is to react. Rather than being paralyzed by uncertainty, focus on the “known knowns”— your financial goals and investing plan— and worry less about transitory periods of market volatility.
Indeed, while we like to keep our models fresh and adaptable to changes in the investment world, we believe the risk of making large changes to our model or investment process based on what could be a fleeting trend is too great. Consequently, we do not make wholesale changes to our approach based on current market conditions. Instead, we adhere to our philosophy and disciplined investment process and carefully evolve our model over time as we incorporate new ideas for capturing anomalies at the stock level. We believe individual investors would do well to follow a similarly disciplined approach.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
Diversification does not assure a profit nor does it protect against loss of principal.
The opinions expressed are those of Scott Wittman, CFA, CAIA, and are no guarantee of the future performance of any American Century Investments portfolio.
For educational use only. This information is not intended to serve as investment advice.