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Benefiting from the uncertainty on the capital markets

by the Team Quantitative Investment Solutions

These days, one thing is certain; uncertainty on the financial markets is still our constant companion. The many geopolitical hotspots and subdued economic prospects sometimes make it difficult for investors to have a clear view of things and can result in sleepless nights. Prices fluctuate more strongly and when this is too extreme, it can be the breeding ground for even more widespread uncertainty among investors. In this type of situation in particular, as we have often observed in the recent past, so-called mean-reversion strategies are increasingly coming into focus. So, what exactly does this mean?

The investment concept can be summarised as follows: you buy certain markets at a time when they are having their worst performance in historical terms in the expectation that they will return to their medium-term trend in the short term. In this context, the inefficiency of markets or irrational investor behaviour play a significant role as possible triggers. On one hand, this inevitably requires a disciplined investment process. On the other hand, it also requires boldness and tends to be difficult for people guided by emotions. In other words, the mean-reversion strategy is based on a systematic approach whose philosophy is to act very opportunistically and always position oneself against current market trends.

This is implemented by a rigorous Mean-Reversion-Model, which checks the degree of market exaggerations (if available) and takes a corresponding counter-position. The investment instruments are exclusively listed liquid futures with a strong focus on developed industrial countries. What is the objective of this approach? The aim is to achieve an attractive market-independent return (3 - 4 percent above the money market rate) with low volatility (long-term volatility target of 4 percent). More specifically, the premise is that the higher the volatility or the divergences within the underlying financial markets, the more trading opportunities open up. This strategic approach has also proven its worth in practice. A look at the historical data shows that by consistently implementing this investment philosophy as an addition to a traditional, conservative portfolio, an improvement was achieved in both the risk and the risk-return ratios. Volatility decreased and the maximum loss was significantly reduced. It is also worth mentioning that this strategy not only pays off in months when prices are falling, but can also be beneficial in an environment where stock markets are positive.

Authors: Björn Esser, Christian Schütz, Dr. Timo Teuber and Moritz Schierholz, Fund Managers of the MainFirst Contrarian Opportunities in the Quantitative Investment Solutions Team

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