Narrative and Numbers in Systematic Investing

Why a Thesis Matters for Your Strategy

Today, let’s set aside the usual chatter about new canaries and strategies. Inspired by a fellow systematic investor, I want to share some thoughts on why having a narrative—a solid investment thesis—is just as crucial in systematic investing as it is in discretionary approaches.

Imagine you come across a stock that’s been performing well over the last decade, yet you’ve never really heard of the company behind it. Would you invest based solely on its historical numbers? Chances are, you’d hesitate. Even if a stock beats its underperforming peers, you’d probably dig a bit deeper to understand the fundamentals driving that success. After all, we all know that past performance doesn’t guarantee future results. And while this might sound like common sense for discretionary investors, I believe it holds true for systematic investing as well.

The Role of a Narrative in Systematic Investing

Systematic—or rule-based—investing isn’t without its quirks. One key challenge is overfitting: the more tweakable parameters your strategy has, the higher the risk of creating a model that shines in backtests but stumbles in the real world. This is where the bias-variance tradeoff comes in. You accept a bit of bias (inaccuracy) to achieve consistency (lower volatility) and more reliable out-of-sample performance. Having a clear narrative behind your strategy helps anchor your approach, reducing the chances of mistaking a lucky simulation for a robust, long-term edge.

Let’s be honest: nothing lasts forever—not a company, not a currency, and certainly not an investment thesis. However, a well-crafted narrative gives you a benchmark to distinguish between a temporary rough patch and a strategy that’s run its course. Take the Baltic Dry Index, for example—a metric I once championed as a leading indicator. While it’s a fascinating tool, it isn’t infallible. Shifts in market dynamics, such as changes in supply versus demand, can easily throw off its predictive power. Understanding why and when your indicators work (or don’t) is critical.

The Upside of Systematic Investing

Why do I lean toward systematic investing? One major draw is its power to mitigate emotional decision-making—the kind that can derail even the best-laid plans. A well-founded systematic thesis also tends to have staying power because it focuses on systemic risks that evolve more slowly than idiosyncratic ones. In contrast, the latter can shift rapidly, potentially rendering a discretionary thesis obsolete overnight.

Let’s face it: backtesting is all about the past. It provides valuable insights but says nothing definitive about the future. That’s why even an impressive backtest isn’t a silver bullet. A strong narrative isn’t just a nice-to-have—it’s a necessity for navigating the uncertainties of the market.

So, what do you think? Do you see narrative and numbers as equally important, or are you more convinced that data alone should guide your systematic strategies? I’d love to hear your thoughts—after all, in investing, just like in any good story, context is everything.