14th Jan 2020 - 3:40pm
Momentum underperformance poses renewed challenges for hedge funds’ alpha
By Hugh Leask | 14/01/2020 - 3:40pm
- The recent underperformance of momentum stocks suggests the prevailing trends of recent years are drawing to a close - potentially making alpha generation increasingly challenging for hedge funds, according to Man Group analysts.
- After more than two years of strong performance, momentum names – trades which capitalise on existing market trends, either upward or downward - suffered a sharp reversal towards the end of 2019.
- Analysts at Man Group, the publicly-listed London-based global hedge fund group which runs a range of quantitative, discretionary and fund of funds strategies, noted a drop-off in shorting activity, potentially reflecting a “difficult environment” for alpha further down the line as the dominant trends of recent years recede.
- They pointed to a decline in the relationship between utilisation - a factor described by analysts as “a proxy for shorting demand” - and momentum in the final months of last year.
- The dramatic momentum sell-off, which began last September, saw investors pile into other factor trades, such as value, with the iShares Momentum Factor ETF sliding 1 per cent and the iShares Value Factor ETF advancing 7 per cent. Managed futures strategies shed 3 per cent during that month, and despite a recovery, hedge funds continued to offload momentum positions well into the fourth quarter.
- “Traders often short companies that are expensive, or have poor momentum or quality scores,” Man analysts observed in a note on Tuesday morning. “During the fourth quarter of 2019, traders appeared to cover shorts in negative momentum names and put on shorts in positive momentum names – which reduced the magnitude of the relationship between momentum and short activity.”
- Traders also appeared to cover shorts in cheap names, slightly increasing the relationship between utilisation and value, said Man.
- Elsewhere, utilisation fell from 5.3 per cent to 4.5 per cent during the fourth quarter of 2019 - equating to a 15 per cent decline in shorting activity across the broader investment universe, analysts noted.
- “The combination of these two may be reflective of a difficult environment for alpha generation, as well as a feeling that the prevalent trends of the last few years may be long in the tooth.”
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