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.”
