Last week, as market participants pondered the potential knock-on effects from the engineered short squeeze that played havoc for some long/short books, there were questions about the ramifications for other investor cohorts.
That’s just a needlessly circuitous way of saying that folks wanted to know whether the GameStop story had the potential to become a bigger event, perhaps via some of the dynamics that have triggered painful, self-feeding selloffs over the past several years.
For his part, JPMorgan’s Marko Kolanovic suggested that investor positioning wasn’t stretched. “Market expectations of volatility and tail risk are still very high,” he said, citing the VIX and variance convexity, on the way to noting that “historically, that’s been the main impediment for institutional buying of equities.” His model for equity exposure of systematic investors showed scant evidence of exuberance when it comes to positioning.
Fast forward to Monday and, in his latest, Nomura’s Charlie McElligott sounded a similar tone, at least as it relates to CTAs and risk parity.
“As far as the ‘deleveraging knock-on’ goes, perhaps the best news of all is that systematic strategies like CTAs and Risk Parity continue to show no evidence of being excessively positioned within Global Equities,” he wrote.
In case that was unclear, he made it more explicit. “Even if short-term CTA model signals turned lower / ‘short,’ there simply isn’t a lot to sell or deleverage,” he remarked. The figure (below, from Nomura) shows the estimated breakdown for CTA exposure across assets and by percentile rank.
On Nomura’s model, then, CTA exposure to global Equities sits in just the 56th %ile since 2011. There’s “room to trim net long exposure, but no real ‘excess leverage’ to purge,” Charlie said.
As alluded to above, that’s good news, as it suggests that even if there were another downdraft that pushed spot below key “trigger” levels, the scope for deleveraging is limited. At least from that cohort.
That doesn’t mean there’s no risk. Dealers are straddling the line when it comes to the threshold for options hedging flows to exacerbate directional moves. And it’s still not clear how vulnerable short books are.
But the message, at least as of Monday, was that this was primarily a fundamental long/short event. McElligott said as much. “It’s about single-name crowding spillover into a de-grossing, but not a macro or systemic phenomenon, unless index breaks down.”
Notably, the vol-control universe (broadly) has the potential to become a pillar of support again assuming things calm down. Short-term realized was yanked higher amid the dramatics, prompting a bout of selling, but as long as the market returns to even a semblance of “rangebound” from here (say, +/- 1% or less), that paring of exposure becomes a supportive bid instead.
Obviously, the game changes (by definition) if something moves the index and puts added pressure on longs, which were sold in the back-half of last week as the dominoes tipped for some funds caught up in the “neon swan.”
As ever, you can get a different answer if you look for it when it comes to systematic exposure depending on who you ask, what you’re asking about, and how the people you’re asking conceptualize of a given investor class. SocGen, for example, suggested Monday that equity positioning in trend following strategies is high.
But one thing everyone generally agrees on is that if the damage to hedge funds is larger than currently known and/or something rattles the broader market, exacerbating already frayed nerves, it could be a problem.
“[The] VIX reacted more strongly than its historical relationship with S&P 500 moves would suggest,” SocGen’s derivatives team said, of last week’s developments. “Whether these levels of volatility persist or not will depend on whether the de-grossing of hedge fund leverage is done for now,” they added, noting that “if funds continue to take leverage off, it will involve them selling their longs as well, which could put further upward pressure on the implied volatility of large caps.”
For his part, McElligott quipped that “[it’s] certainly safe to say that nobody stress tests their books to experience a 13 or 10 standard deviation move.”