– David Wanis, April 2025

“’First she said we were to keep clear of the Sirens, who sit and sing most beautifully in a field of flowers; but she said I might hear them myself so long as no one else did. Therefore, take me and bind me to the crosspiece halfway up the mast; bind me as I stand upright, with a bond so fast that I cannot possibly break away, and lash the rope’s ends to the mast itself. If I beg and pray you to set me free, then bind me more tightly still.’

I kneaded the wax in my strong hands till it became soft … I stopped the ears of all my men, and they bound me hands and feet to the mast as I stood upright on the cross piece; but they went on rowing themselves.

When we had got within earshot of the land, and the ship was going at a good rate, the Sirens saw that we were getting in shore and began with their singing … when we had got out of hearing of the Sirens’ voices … my men took the wax from their ears and unbound me.” – Homers Odyssey

As fundamental investors, we often think of the systematic component of our investment process like ropes lashing us to the mast while the sirens of the market tempt us to stray from our determined investment discipline. The temptation is the noise and novelty of markets. A permanent feature – but one that continues to create new opportunities for human behaviour and over reaction.

I was asked at a recent conference – held in early April – if this environment (meaning the post Trump tariff volatility) was creating uncertainty in markets which should perhaps have clients rethink their investment approach. After some thought, I realised that probably the last year when market participants didn’t have some worry de jour making them believe markets were in uncharted territory was 2007. Ironically that was the year everyone should have been very very worried indeed.

The Longwave systematic investment process, which has been developed over many years, is designed to help us find and construct a diversified portfolio of small cap businesses most likely to outperform over the medium term in most market environments. It has nothing to say about the contemporary topics of excitement or concern singing out to investors and luring them into “doing something”. If mis-pricing opportunities do emerge, the fundamental side of our process is designed to take advantage of those, but having the systematic experience makes us more judicious in spotting true opportunity as opposed to just noise.

I remember post the GFC when factor ETFs were being launched globally. The basic premise was “why pay your Value Manager a fee for alpha, when all they are really capturing is a simple value factor you can now buy much cheaper”, which was a good observation for the investor, not so great for the poor value managers.

This spawned an entire industry hunting for factors and back tests which could be packaged into ETFs and sold to unsuspecting investors. What investors were unsuspecting of was the ease with which a back test could be over-fitted to any historic sample (say the past 15 or 20 years) to show amazing and statistically significant performance which completely evaporated out-of-sample once the ETF launched.

When we started research on our own systematic process, aimed specifically at small caps and informed by many years of fundamental investment experience rather than using academic factors, we were highly alert to these back testing pitfalls. Our goal is not to find the “best” back test, rather it is to build a systematic process which captures our fundamental view on how value is created or destroyed in small companies and build portfolios which are robust to uncertainty.  They need to perform out of sample (which they have since 2013) and with real money (which they have since 2016).

By embedding our ideas in a systematic process, it creates a higher bar – a stronger rope – for us to meet when we are faced with uncertainty, volatility, noise and a view that “surely this time is different”. It reminds us that in both the back test, and the out of sample / real money period the process worked while being completely ignorant of all the contemporary news that investors of the day believed were the most important, including the GFC (2008), European Debt Crisis (2011), bursting of the China / Commodities bubble (2014), Fed Hikes and China Trade War (2018), COVID 19 pandemic (2020), Ukraine invasion, inflation and interest rate shocks (2022), US Regional bank crisis (2023) and now Trump Tariffs (2025). One thing is guaranteed – there will be more uncertainty in the future.

Another lesson our systematic research has taught us relates to the different sources of excess return. For example, over many years, investors can outperform the market by taking greater amounts of specific risk (such as debt default risk, liquidity risk, bankruptcy risk, product risk, concentration risk, and beta risk) while the market ignores it. These risks can be easy to ignore as they are less obvious. Celebrating these gains is like the Turkey celebrating its prosperity in the weeks before Thanksgiving. Eventually when the market prices the risk, many years of gains can be reversed in a matter of months.

Returns from themes are different. These tend to have a compelling narrative attached to them (think AI & data centres, EVs & lithium stocks, nuclear power & uranium producers, etc) and the exposure to the theme in the short term is all that matters. The risk is hardly hidden as many of the companies riding high on thematic inclusion have terrible fundamentals – which everyone can see, but investors playing this game wantonly ignore, often because the stocks are packaged and sold as a group (in an ETF) rather than carefully scrutinised as individual investments.

And finally, factors – the hidden source of return many 20th century fundamental investors discovered through trial and error but since industrialised and scaled by global quant funds. The jury is out on whether excess returns from simple factors like size, value, growth, quality and minimum volatility have been competed away or are just becoming more cyclical.