The investment 'universe' is the term used to define the set of assets to research and trade.
There are simply too many securities in the world to monitor, so we must narrow our focus to a subset of these. We can filter by asset class by choosing to only invest in stocks and exclude bonds, currencies, and commodities for example. We can also filter by geography, exchange, market capitalisation or liquidity for example. Our choice of universe dictates a lot about the potential risk and return of our investments. Each investor has different preferences on what kind of securities they want to research. This could be based on what country they live in or their particular interests and/or experience.
Let's take a look at how we construct our top-level universe of equities at Aikido Finance. We apply the following filters by default:
Let's take a look at how many stocks this leaves us with. Since we research and backtest strategies on a point-in-time basis, the universe of investable stocks changes over time as we can see.
The Aikido universe ranges in size from ~2700 to ~4500 stocks, after applying the filters we described above. Note the large expansion in 2020 when a thousand new companies were listed. There has been a sharp decline since 2021 as many companies have delisted in the current market drawdown in 2022.
With the Xplore Stocks tools, we allow users to filter our preselected universe by small, mid and large market capitalisation and sector so our users can design strategies that suit their personal needs.
The first option is to select the range of market caps that you'd like to invest in. You can choose from Small-Cap, Mid-Cap, and Large-Cap. The default is to use the whole universe of stocks so we auto-select all the market caps.
Let's take a look at a chart to make this a little clearer. We'll plot the average market cap of each bucket (small, mid, and large cap) across time.
Since 2010, the average market cap of the Small-Caps is ~$500M, the average market cap of the Mid-Caps is ~$1.5B, and the average market cap of the Large-Caps is ~$5B.
The final step of defining your universe is to choose your sectors. There are 20 sectors in total covering a very broad range of industries. We normally suggest using a broad set of sectors when creating your investment strategies so you limit your exposure to very concentrated sectors. However due to the market dynamics some sectors are just naturally a lot larger than others, as we will see, so some sector risk is unavoidable. Let's look at the data to help explain the sectors a bit more.
As we can see from the above breakdown, the Financial sector accounts for ~26% of our universe. Contrast that to the Communications sector, which comprises only ~1.5% of all entities. The top 3 sectors account for over 50% of the universe. Now, let's look at each sector's market cap.
In the above chart, we have summed the market cap of each sector. We can see a more even spread across the sectors. Technology Services has the largest market cap with ~17% while the Distribution Services sector lags behind at just ~1%.
Be mindful of how you choose your investment universe and use the above data to guide your decision. If you filter too aggressively, in terms of market cap and sectors, you might end up with a very small universe size - which may be riskier and could negatively impact your returns.
Start exploring and testing your investment ideas with intuitive pro-tools. Have fun constructing your personalized investment strategies and let us know any feedback.