Retail investor beliefs

August 3, 2019

Survey evidence suggests that retail investors adjust positions rather sluggishly to changing beliefs and the beliefs themselves contradict classic rationality. Sluggishness arises from two features. First, the sensitivity of portfolio choices to beliefs is small. Second, the timing of trades does not depend much on belief changes. Contradictions to classic rationality arise because different investors cling stubbornly to different beliefs with little convergence. Also, retail investors associate higher returns with higher economic growth expectations and lower returns with fears of large drawdowns (contradicting the notion of tail risk premia). Overall this suggests that retail investors feel better informed than the market, with no need for updating their beliefs quickly and thoroughly. Opportunities for professional macro trading may arise through front running retail flows and applying more consistent rationality.

(more…)

The relation between value and momentum strategies

July 20, 2019

Simple value and momentum strategies often end up with opposite market positions. One strategy succeeds when the other fails. There are two plausible reasons for this. First, value investors regularly bet against market trends that appear to ‘have gone too far’ by standard valuation metrics. Second, value stocks carry particularly high market risk or ‘bad beta’ and thus fare well when market risk premia are high and the market turns for the better. This typically coincides with ‘momentum crashes’ in oversold markets. As a consequence, value and momentum signals may be complementary. In particular, value strategies are not very profitable in normal times or bull markets but have produced extraordinary profits when being set up in the mature state of a bear market. Similarly, momentum signals can be adjusted by extreme valuation metrics alongside signs of trend exhaustion.

(more…)

Why herding is the death of momentum

February 2, 2019

Momentum trading, buying winning assets and selling losing assets, is a most popular trading strategy. It relies on sluggish market adjustment, allowing the trader to follow best-informed investors before the more inert part of the market does. Herding simply means that market participants imitate each others’ actions. Herding accelerates and potentially exaggerates market adjustments. The more quickly the herd moves, the harder it becomes to follow informed leaders profitably. In a large agile herd, sluggish adjustment gives way to frequent overreaction. Momentum strategies fail. This suggests that popularity and commoditization of momentum strategies (and trend-following) are ultimately self-defying. Conditioning momentum strategies on the estimated degree of herding should produce superior investment returns.

(more…)

Basic theory of momentum strategies

January 27, 2018

Systematic momentum trading is a major alternative risk premium strategy across asset classes. Time series momentum motivates trend following; cross section momentum gives rise to ‘winners-minus-losers strategies’. Trend following is a market directional strategy that promises ‘convex beta’ and ‘good diversification’ for outright long and carry portfolios as it normally performs well in protracted good and bad times alike. It works best if the underlying assets earn high absolute (positive or negative) Sharpe ratios and display low correlation. By contrast, cross section momentum strategies benefit from high absolute correlation of underlying contracts and are more suitable for trading assets of a homogeneous class. The main pitfalls of both momentum strategies are jump events and high costs of ‘gamma trading’ conjoined with high leverage.

(more…)

Passive investment vehicles and price distortions

November 11, 2017

The share of passive investment vehicles in financial markets has soared over the past 20 years. In the U.S. equity market it has risen from 12% to 46%. There is reason and evidence suggesting that this will lead to more market price distortions. First, index effects on prices have gained importance relative to other price factors. Second, there has been a reduction of differentials across equity returns within indices. And third, the rise in passive investment vehicles has coincided with the expansion of momentum strategies in active funds, giving rise to vast flows that all explicitly neglect fundamental value.

(more…)

Trend following and the headwinds of rising yields

April 2, 2017

The decline in bond yields over the past decades has supported profitability and diversification value of trend followers. Returns have been boosted by a persistent secular downward drift in interest rates and persistent positive carry. Diversification value owed to negative correlation of long duration positions with equity and credit returns, reflecting the dominance of deflationary over inflationary shocks. However, in a rising yield environment carry would work against the trend follower, while diversification value is dubious. A simple simulation that reverses the yield dynamics over the past 15 years suggests that a generic trend following strategy could perform poorly in a rising yield environment.

(more…)

Cash hoarding and market dynamics

March 11, 2017

Institutional asset managers can aggravate market swings due to the pro-cyclicality of redemptions, internal leverage and cash positions. A new empirical analysis shows that cash hoarding, a rise in funds’ cash positions in times of redemptions, is the norm. Cash hoarding seems to be particularly pronounced in less liquid markets and is a rational response if fire sale haircuts are prone to escalate with growing flows, i.e. if liquidating late is disproportionately costly. Investment opportunities arise initially from timely positioning and subsequently from the detection of flow-driven price distortions.

(more…)

Lessons from long-term global equity performance

February 11, 2017

A truly global and long-term (116 years) data set for both successful and failed financial markets shows that equity has delivered positive long-term performance in each and every country that did not expropriate capital owners, even those that were ravaged by wars. Also, equity significantly outperformed government bonds in every country, with a world average annual return of 5% versus 1.8%. The long-term Sharpe ratio on world equity has been 0.24 versus 0.09 for bonds. Valuation-based strategies for market timing have historically struggled to improve equity portfolio performance. Active management strategies that rely on both valuation and momentum would have been more useful.

(more…)

Corporate bond market momentum: a model

September 3, 2016

An increase in expected default ratios naturally reduces prices for corporate bonds. However, it also triggers feedback loops. First, it reduces funds’ wealth and demand for corporate credit in terms of notional, resulting in selling for rebalancing purposes. Second, negative performance of funds typically triggers investor outflows, resulting in selling for redemption purposes. Flow-sensitive market-making and momentum trading can aggravate these price dynamics. A larger market share of passive funds can increase tail risks.

(more…)

Trend following as tail risk hedge

July 18, 2016

Typical returns of a trend following strategy carry features of a “long vol” position and have positive convexity. Typical returns of long only strategies, such as risk parity, rather exhibit a “short vol” profile and negative convexity. This makes trend following a useful complement of long-only portfolios, by mitigating tail risks that manifest as escalating trends. Options are naturally a cleaner hedge for tail risk, but have over the past two decades been prohibitively expensive.

(more…)

Tags

Tags
asset management Asset Purchase Program banks bond returns bond yields bubbles capital regulation carry China collateral commodities credit returns default ECB economic data EM equity returns euro area crisis Fed financial crisis FX FX interventions FX returns government debt government deficits herding inflation information insurances Japan leverage liquidity machine learning market turmoil price factors regulation risk management shadow banking statistical methods term structure trend following variance risk premium VIX volatility ZLB
ABOUT US

Macrosynergy is a London based macroeconomic research and technology company whose founders have developed and employed macro quantamental investment strategies in liquid, tradable asset classes, across many markets and for a variety of different factors to generate competitive, uncorrelated investment returns for institutional investors for two decades. Our quantitative-fundamental (quantamental) computing system tracks a broad range of real-time macroeconomic trends in developed and emerging countries, transforming them into macro systematic quantamental investment strategies. In June 2020 Macrosynergy and J.P. Morgan started a collaboration to scale the quantamental system and to popularize tradable economics across financial markets.

FOLLOW US
Linkedin
LEGAL
Research
Quantamental Academy
About Us