By Justina Lee
(Bloomberg) — The kind of quant shock seen this week was
supposed to happen once in every
,000,000,000,000,000,000,000,000,000,000 days, according to Jon
In retrospect, the manager at Great Lakes Advisors wonders
whether he should have seen it coming.
Just a day after he watched CBS’s “60 Minutes” about
America’s unprecedented efforts to deploy a coronavirus vaccine
when it comes, Pfizer Inc. revealed significant progress on its
pandemic cure. That revelation spurred the biggest moves ever in
Quigley’s $3.9 billion portfolio.
While stock benchmarks cheered the news, some of Wall
Street’s most popular styles of quant trading were hit in a
“Events happened that statistically never could happen,”
said the chief investment officer of disciplined equities in a
telephone interview from St. Petersburg, Florida.
As money managers rushed to price in stronger economic
growth, factor investors who dissect stocks by how much they’ve
risen or fallen saw this strategy, known as momentum, crash on
Monday like never before. Equities more sensitive to the
economic cycle like value and small-cap names skyrocketed.
So while the S&P 500 is just shy of its record high, it’s
been a wild week for quants even by the standards of this wild
year, with many enduring violent moves rather than capitalizing
on the risk-on mood.
All this recalls long-standing worries that freakish cross-
asset gyrations are getting more common thanks to cheap money
and investor crowding.
Quigley’s estimate for the odds of this week’s shock is in
part tongue-in-cheek, based on a rule of thumb for a normal
distribution of statistical data. Asset moves are not known to
reliably obey this convention that says 98% of all data points
occur within three standard deviations of the mean.
But even with the knowledge that market prices are more
prone to outlier moves, a rotation of the magnitude seen this
week was still a shock to risk models.
Quigley’s small- and mid-cap strategy posted an eight-
standard deviation drawdown compared with its forecast tracking
error, he wrote in a letter to clients. Its large-cap portfolio,
a three-standard deviation one.
This is a problem because quants decide how much market
exposure to take by using historic data to calculate the odds of
a fund’s positions imploding. If the distribution of price moves
has changed from the past, history may no longer be a reliable
guide to the present.
A rotation isn’t always a bad thing for active managers,
but this week’s was so extreme that few investors were
positioned for it. As a result hedge funds’ alpha, or excess
returns, fell the most since March on Monday, and systematic
funds suffered even more, Goldman Sachs’s prime brokerage data
By Wednesday momentum was rebounding, jumping the most
since June to underscore just how volatile factors have become.
Meanwhile, post-election relief may be helping the Cboe
Volatility Index retreat, but that doesn’t mean it’s all smooth
sailing for the benchmark.
Monday’s vaccine-powered rally meant the S&P 500 broke out
of the trading range expected by the options market for the
third week in a row. Since options are used to anticipate and
protect from moves, that’s another sign of just how big the
shocks have been.
Freakish swings of late have been blamed on cheap money,
fast-money herding and thin liquidity. In August, Societe
Generale quants used two decades of data to show that stocks and
junk bonds have become more prone to fast gains and losses than
ever before. Or in technical terms, the tails of a distribution
of price data are getting fatter.
Quants are no strangers to the suggestion many of their
strategies are built on historical data that might not repeat.
But the idea is that, over a long enough time horizon, certain
rules hold true — and only looking at the recent past gives a
limited view of asset behavior.
All the same, investors who tie their allocations to risk
models look unlikely to put more money to work while these wild
factor gyrations are ongoing.
In a Capital Market Risk Advisors survey on lessons from
2020, risk managers concluded that they need to conduct more
stress tests that aren’t simply based on historical scenarios —
and should sometimes use their “gut feelings” when it comes to a
shock as unquantifiable as Covid-19.
“It’s not a coincidence we’re seeing more 6 sig+ moves
relative to history,” Cem Karsan, founder of Aegea Capital
Management LLC, tweeted, using the symbol denoting standard
deviation. “These aren’t your father’s equity markets.”
–With assistance from Melissa Karsh and Lu Wang.
To contact the reporter on this story:
Justina Lee in London at email@example.com