It’s been a long time coming, but the week(s) of reckoning have finally come for CTAs and the risk parity crowd.
Of course the “serious people” reading this will say the “day of reckoning” bit is hyperbolic.
After all, we haven’t seen a sustained vol. spike of the sort that would probably be required to cause a truly painful unwind where “truly painful” means “something people who don’t know what CTAs and risk parity are” would notice.
But the important thing about what we’ve seen over the past couple of weeks is that it illustrates the interplay between two of the most talked about systematic strats and the delicate situation central banks are trying to negotiate as they roll back stimulus.
A coordinated hawkish lean from central bankers that began with Mario Draghi’s “we’ll look through transitory weakness in inflation” comments that hit two Tuesdays ago and one seemingly innocuous trigger event (a weak French 30Y auction) conspired to create what might fairly be called a “mini-tantrum” in DM rates over the past two weeks and that’s spilled over into equities.
Here’s the “mini-tantrum” with the two events noted above highlighted in red:
And here’s a modified version of a popular meme to explain:
Well, as Goldman put it on Monday, “rates are currently part of the risk to equity, rather than the support.” That’s the whole reason why people are concerned about rapidly rising DM rates. Because rates have been so low, for so long, the so-called “tantrum threshold” has been reduced. Or, in other words, the level beyond which rates must rise to trigger a concurrent selloff in equities is lower than it once was.
Ok, so with that in mind, consider this from Bloomberg’s Dani Burger:
Hawkish signals from central bankers have punished stocks and bonds alike in the past week.
Also punished: investors who make a living operating in several asset classes at once. They’ve been stung by the concerted selloff that lifted 10-year Treasury yields by 25 basis points and sent tech stocks to the biggest losses in 16 months. Among the hardest-hit were systematic funds who — either to diversify or maximize gains — dip their toes in a hodgepodge of different markets all at the same time.
Losses stand out in two of the best-known quant strategies, trend-following traders known as commodity trading advisers, and risk parity funds. CTAs dropped 5.1 percent over the past two weeks, their worst stretch since 2007, according to a Societe General SA database of the 20 largest managers. The Salient Risk Parity Index dropped 1.8 percent, the most in four months.
Here’s a look at SocGen’s CTA index (mentioned above):
Panning out for perspective the picture looks like this going back to 2003:
And here’s risk parity (for those interested in more see “The Risk Parity Unwind Is Underway — But One Strategist Says It’s Fine“):
As Burger goes on to note, “last week’s pain wasn’t as clear cut as a selloff in fixed income for some trend-followers. The managed futures fund at Salient, for example, suffered from a short position in agricultural commodities after wheat futures rallied to four-year highs.” If you’re interested in the wheat futs story, you can read more on that here.
Now obviously, risk parity isn’t going to deleverage as quickly as the trend followers, but a whole shit load of caveats (all of which you can review for yourself in Burger’s piece linked above) notwithstanding, we’ve gone from talking about why these things won’t begin to unwind to talking about how the beginning of the unwind probably isn’t exacerbating wider market moves.
That’s a slippery slope.
Because the next conversation we’ll be having is one about how although they’ve exacerbated wider market moves, it’s unlikely to get much worse.
And then after that, when some exogenous shock triggers an August 24, 2015-ish meltdown, we’ll all be asking if an already bad situation was made immeasurably worse by mechanical selling.
Perhaps Brean Capital LLC’s Peter Tchir put it best: “I don’t think this move has caused much of an unwind from true risk parity funds, but much more from the homebrew or risk parity lite crowd — making the real fun just beginning,”