Factor investing strategies, described in a recent Bloomberg article as the “$2 trillion corner of the quant world,” are seeing the highest level of correlations in two decades and are “failing to live up to their diversification label in an era when recession-spurring lockdowns, rally-inducing stimulus and game-changing vaccines are all moving markets.”
Franklin Templeton analyst Josh Russell explained it this way: “A multi-factor strategy is placing a lot of bets. If all of these collapse into one unidirectional bet, you really lose your edge.” Which means, the article says, investors who “once believed that stocks with high dividend yields, for example, will move independently from those with big profit margins are getting confounded again and again.”
The good news, however, is that high correlations, which tend to track periods of market stress, tend to be short-lived, according to the article: “Many quants will be hoping now that as people get vaccinated and economies recover, factors will move to their own beat again and trade on the fundamental rules discovered by academics decades ago.”
The article cites comments from Blueshift Asset Management CEO Mani Mahjouri, whose firm is described as a “quant hedge fund that neutralizes its factor exposures”: “The impact we’ve witnessed is that these common sources of return are really focused on the outcome of the disease. The volatility is definitely higher, and the diversification benefit has been nullified.”
Blueshift’s analysis has shown that the pandemic has prompted investors to crowd into “stay-at-home haven trades, turning them into extreme momentum and low-volatility bets. Meanwhile, Covid-sensitive shares are moving in the opposing direction to notch a strong negative correlation with their defensive peers.”
While the article notes, “That’s a far cry from what is supposed to happen,” it adds, “it may be wishful thinking to conclude factor investing is misfiring because of the pandemic pure and simple.” Many fear that quant strategies have become more prone to crowding and “fickle money flows,” although there are also those that believe the high factor correlation will subside and that 2021 could show promise for stock pickers.