Indices That Prove a Trend Validation Point for Investment Managers

[Active managers are expected to deliver alpha and beat indices. Unfortunately, according to the 2020 Year-end SPIVA scorecard, more than 50% of mutual funds underperform their relative benchmarks. Traditional investment strategies alone seem to be unable to capture the changing dynamics of markets in a more complex world where big money flows dominate. The price trends of stocks are driven by a variety of factors where the fundamentals of a company are just one, and not always the dominant driver. Sentiment, social media, macro developments, faster readjustments from big money have a large impact in starting and accelerating price trends. A company with good fundamentals and positive coverage from analysts does not necessarily turn into a profitable investment within a reasonable time.

A solution may be to go to the core of the problem by paying attention to the actual price trends across stocks and sectors. As it is impossible to know what are the factors that are most impacting the price development of a security, just simply analyze the result of the forces at work - analyze and measure the trend.

To learn more, we went to the source of this proposed trend validation solution for active money managers by speaking with Institute member Rocco Pellegrinelli, CEO of Trendrating - a Swiss InfoTech company providing advanced price trend capture analytics for RIAs and active investment managers. In 2020, Rocco was nominated as one of the “10 Most Inspiring CEOs to Watch” by Industry Tech Outlook, as well as one of the “10 Best Innovative Leaders” by DigiTech Insight.

Trendrating’s recent launch of six new indices that incorporate a “trend validation” methodology was to prove a point. We asked him questions to better understand how their indices and model portfolios seek to demonstrate that adding a layer of intelligent trend validation and selection to any investment strategy can generate alpha and help beat benchmarks.]

Hortz: What was your thinking behind launching these new indices and why the range of indices that you chose?

Pellegrinelli: We decided to provide evidence that by adding a layer of trend rating and validation to any investment strategy, you can generate alpha via profiting from the performance dispersion that is observable in their underlying investment universe. So, we applied our methodology to three sample strategies - value, growth, and large-cap. All the indices prove the point by beating the relevant benchmarks.

Our message to active investment managers is by incorporating into your investment strategy an element of trend validation, one can profit from the performance dispersion observable in any investment universe. This phenomenon can be a gold mine for active managers that have the right tools to capture at least part of these price trends.

Hortz: What kind of data and processes are embedded in your proprietary price trend analytics?

Pellegrinelli: The model was built and massively tested over the years and has been live since 2013. It is a sophisticated, multi-factor model that incorporates several indicators and self-adjusts on volatility changes. The outcome is a very actionable rating methodology separating bull and bear trends with a medium-term horizon with good accuracy; well above other old-school tools.

Hortz: How exactly can active investors use your trend rating methodology?

Pellegrinelli: Our analytics can enhance different tasks. For individual stocks it is possible validating investment ideas and spotting risks early via downgrade alerts. For portfolios management, we can enable the calculation of the aggregated portfolio rating. The wrong “trend allocation” is the main reason behind poor performance. If, for example, the “portfolio rating” is below the aggregated rating of a benchmark, then the risk to underperform is real. Furthermore, one can use our methodology as an overlay to any investment strategy and use our technology to test and compare the performance in the past and then track in real-time before executing.

A further time-saving option is to utilize our smart model portfolios that are based on a series of Trendrating indices and profits from the combined power of strong fundamentals and capturing confirmed price trends. Our process is geared to maximize returns and reduce the risk of under-performance.

Hortz: What have been the results of adding this trend validation & selection overlay?

Pellegrinelli: Our indices show that by adding this extra layer of market intelligence, it is possible to beat the benchmarks and exploit the opportunities offered active managers by being more in synch to profit from price trend dispersion. Our customers use our data as a critical part of their decision process and the reason is obvious. Checking more quality boxes, from different angles, can only make the process more robust.

Hortz: What do the results prove as to the forces in play that asset managers may not have been capturing?

Pellegrinelli:  Why do many mutual funds continue to underperform their benchmarks, despite the investments they make in data and research? In my opinion, it is that many still base decisions primarily on fundamental data and do not develop an adequate attention to the actual price trends. They do not go beyond personal opinions and analysts’ views.

At the end of the day, portfolio performance is the combined result of the individual stock trends that have been captured. The market is impacted by new forces at work where fundamentals alone cannot capture the changed dynamics. But the good news is that alternative data, advanced analytics, and latest generation tools are available to compliment investment decision making and fill the gap of wide performance dispersion.

Hortz: How do the results specifically help RIAs and active asset managers in stock selection?

Pellegrinelli: Advisors and managers can enrich their decision process with a pragmatic sanity check and an objective quality control system based on what impacts their performance – getting the trends right. For example, over the last 12 months in the US large cap universe, the top 25% performers gained on average 131%, the mid 50% recorded a gain of 40%, and the bottom 25% produced 3%. Tracking and rating price trends of individual stocks can enable portfolio managers to try and capture part of the top performers while limiting the exposure to the losers.

Hortz: Any other thoughts or recommendations you would like to offer active investment managers?

Pellegrinelli: Trendrating indices provide hard evidence of our methodology that is designed to outperform passive benchmarks on a consistent basis across different market cycles. A new generation of advanced analytics and strategy management systems are here to enable pragmatic and passionate managers to win the active-passive debate.

We feel this is a defining time for many active managers that can survive and prosper from the evolving dynamics of the markets, if they are able to strategically adopt and profit from innovations. But the resistance to change and the protection of the status quo are very strong in some organizations and investment professional mindsets. We suggest very strongly that ignoring the importance of assessing and validating individual price trends is very risky.

We invite you to visit our website to learn more about our indices and smart model portfolios that combine fundamental metrics and factor in for price dispersion and capturing price trends. We would like to demonstrate how delivering superior returns on a consistent basis can be aided with the adoption of advanced analytics and models.

And we are so confident about the real value we can deliver and the disruptive nature of our investment technology, that we would like to offer advisors and asset managers a special pricing structure subject to generating alpha via our methodology. We are serious when we say that it is time to really help active managers with a proposition that changes the game.

Institute for Innovation Development is an educational and business development catalyst for growth-oriented financial advisors and financial services firms determined to lead their businesses in an operating environment of accelerating business and cultural change. We position our members with the necessary ongoing innovation resources and best practices to drive and facilitate their next-generation growth, differentiation, and unique client/community engagement strategies. The institute was launched with the support and foresight of our founding sponsors - Ultimus Fund Solutions, NASDAQ, Pershing, Fidelity, Voya Financial, and Charter Financial Publishing (publisher of Financial Advisor and Private Wealth magazines).