The impact of systematic flows — and particularly systematic selling — on equities is a source of perpetual fascination for market participants.
If you’re steeped in the subject matter, this is all just par for the course. At any given time, depending on the setup, systematic flows can perpetuate melt-ups, exacerbate downdrafts or insulate range-bound price action.
Typically we think of vol control, CTAs and risk parity when we discuss systematic flows, but it’s important to include option hedging dynamics given the extent to which dealers’ position management needs can amplify directional moves, triggering systematic buying and selling in the process.
As we look ahead to Q4 and, more to my point here, back at a two-month equity correction inspired by unruly rates, it’s worth taking stock of systematic selling. According to estimates from Nomura’s Charlie McElligott, systematics accounted for “the vast majority of the deallocation flows over the past three-month window.”
The figure above gives you a sense of things. Systematics sold nearly $50 billion over that period.
Recall the setup in late July: The steady decline in realized vol left vol control sitting on a pile of equity exposure. That setup (i.e., high %ile exposure against a low departure point for any vol expansion) was perilous.
Headed into the late-summer selloff, McElligott warned on that juxtaposition, calling attention to “enhanced risk of mechanical deleveraging due to extreme long exposure” in a “low base vol environment.” Time and again he reiterated that “just a modest reset higher in realized vol” could prompt a meaningful de-allocation flow. As the chart shows, that’s just what happened.
On the bright side, that means exposure in the systematic space is now cleaner and “tilted much better to buy locally, as it relates to proximity of spot triggers for CTAs,” McElligott said Thursday, adding that the target vol universe could see “meaningful” exposure adds if (note the emphasis) the distribution of daily spot outcomes for the S&P can compress back into the +/- 50bps range.
