With the largest sell-off in US equities since the pandemic now behind them, trend-following quant funds are gearing up to re-enter the stock market, and the normalisation process could be quicker than usual, according to a report by Bloomberg.
In the past month, systematic funds that trade on market signals and volatility rather than company fundamentals, have offloaded a record amount of equities.
But with markets stabilising, the Cboe Volatility Index (VIX) trading around 15, and economic indicators suggesting the Federal Reserve closing in on ensuring a soft landing, these funds are poised to increase their stock purchases.
“Should markets stabilise and economic data improve, funds are likely to contribute more significantly to buying pressure,” Barclays PLC strategists noted in a client report on Monday.
Volatility control funds, which adjust their holdings based on fluctuations in the VIX, sharply reduced their equity exposure from about 110% to 50% during the recent spike in volatility. As the VIX returns to previous levels, these funds are expected to restore their positions.
And according to the rapid nature of recent volatility shifts might lead to a quicker normalisation process. “We believe the adjustment could be faster this time, potentially within weeks rather than months,” said Anshul Gupta, head of European Derivatives and Global QIS at Barclays.
Commodity trading advisers are also likely to add to buying pressure. Having previously unwound their equity longs due to growth concerns, commodity trading advisors are also likely to look for bullish market trends to increase their positions, adding to buying pressure.
“CTAs focus on asset price trends, and if the market continues to rise, they may quickly reestablish their long positions,” Gupta added.
Risk parity funds, which aim for low volatility and stable correlations within asset classes, had cut back their equity holdings during last week’s volatility. With the market now stabilising, these funds are also anticipated to begin buying stocks again.
The S&P 500 has risen 6.8% since 5 August, recovering from declines that began on 1 August. This uptick comes amid growing expectations that the Fed might start cutting interest rates in September and ongoing earnings growth extending beyond major tech companies.
