Quant world: March 2020
I just read a recent Bloomberg article that raises concerns about whether a Fed's gradual retreat from the Treasury market would lead to the return of highly leveraged strategies by hedge funds. Here’s the background story…
According to this BIS article, we know that US treasuries experienced high volatility during mid-March 2020. This is odd because treasuries are a safe haven for investors selling stocks (as it happened during the covid crisis). Why did it happen?
Highly leveraged hedge funds held large treasury positions as part of their 'relative value' strategies—profiting from differences in the yield between cash treasuries and treasury futures. Hedge funds borrow through repo to buy treasury positions while selling treasury futures.
Unfortunately, as volatility picked up and futures maintenance margins surged, futures-implied yields dropped more than bond yields. This imposed losses on hedge funds, which were forced to unwind their treasuries positions. De-risking quickly spread to quant funds in a way that resembled the August 2007 ‘quant quake’.
Now, the policy lesson is: why do we allow leveraged funds to dislocate a market that should be long-term oriented and less prone to speculative trading? In short, we should not! John Authers came to similar conclusions in this article comparing last March events with the 1998 LTCM failure.
Even Renaissance Technologies incurred losses last March, blaming circuit breakers for making it difficult to liquidate equity positions. Apparently, as the article says, “Renaissance isn’t magic...If Martians invade, they haven’t got a model for Martians invading.”
Barry Ritholtz would beg to differ. As he puts it, "would you like to generate 40% annual returns for three decades? ...Well, forget about it." RenTech's Jim Simons is a "once-in-a-lifetime talent."
Want to know more about Jim Simons? I highly recommended this podcast with Gregory Zuckerman on his amazing book The Man Who Solved the Market: How Jim Simons Launched the Quant Revolution.
Moving on…
SocGen is now touting a quant strategy based on equity repo trades. It would speculate on the cost of borrowing against a basket of stocks from the EuroStoxx 50 Index. The equity repo market was thus far untouched by quant strategies.
Another interesting development in quantland is how fund managers are becoming ESG evangelists by finding trading signals in ESG investing. BoA estimates that investors will pour $20 trillion into ESG funds in the next 20 years. Learn more here.
That’s it. See you next month!