New factor analysis by Two Sigma shows impact of GameStop debacle on crowded bets

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New analysis by quantitative hedge fund Two Sigma Investments reveals how last month’s ‘Reddit raid’ by retail traders upended factor-based investment metrics, as the fallout from the GameStop saga continues to reverberate across the hedge fund industry.

Data from the New York-based systematic hedge fund’s quant risk analytics tool, the Venn Factor Lens, which categorises and measures the performance of market risk across a range of factors – including Value, Momentum, Equities, Crowding and more – shows the impact of January’s disruption on asset classes.

The Venn system’s Crowding factor – a measure of short exposures to stocks across a wide investment community holding of short positions – suffered an historic slide, down 4.96 per cent in January, a -5.7 standard deviation event.

Exposure to the Crowding factor has historically generated positive returns, Two Sigma said, delivering a 0.92 Sharpe ratio since the factor’s start date in January 2008.

But last month’s co-ordinated push by online traders to drive a number of shorted stocks higher, most notably GameStop, resulted in large losses for some hedge funds – and led Venn’s Crowding factor to its worst month since its inclusion on the platform.

Elsewhere, Two Sigma’s deep-dive analysis also revealed considerable disparity across Equity style factors, with a “a lot of action” that ultimately led to “the most extreme performance” in January.

Having earlier gained 3.5 per cent mid-month on the back of stock market buoyancy over vaccine rollouts and further stimulus, the wider degrossing in global equities – sparked by hedge funds’ panic in the wake of GameStop - meant the Equity factor finished January down some 0.17 per cent.

On the flipside, small cap stocks – as measured by Venn’s Small Cap factor - which spent much of 2020 “unloved” amid the coronavirus-induced recession, roared upwards in January and outperformed larger caps, with the Small Cap factor advancing 3.43 per cent. 

Meanwhile, Value, another underperforming factor in 2020, rebounded in January to end the month up 1 per cent, while Momentum stayed roughly flat for the month. Low Risk stocks underperformed their higher-risk counterparts, causing the factor to tumble 2.98 per cent for the month.