Fast-Money Quants Still Have Some Bearish Stock Ammo Left

(Bloomberg) -- After the worst week for stocks since the financial crisis, Wall Street is peering into an opaque corner of systematic investing for clues on whether Monday's rebound can last.

Investment banks reckon that quants which typically follow the market trend, dubbed commodity trading advisers, have cut longs en masse after a wild week of trading. Whether they need to sell more is now a topic of debate.

JPMorgan Chase & Co. reckons the cohort have started betting against equities after slashing their exposure by in effect $350 billion in recent weeks. Nomura Holdings Inc. suggests they won't turn net short until the S&P 500 breaches 2,800, about 7% below current levels. That implies the market would have to absorb billions more in automated selling if this stock recovery fizzles out. Deutsche Bank AG analysis meanwhile suggests CTAs are now “slightly short.”

Talking directly to these quant shops, who hold futures contracts for periods of days or weeks, shows a similarly mixed picture on positioning. All told, given their limited bearish exposures, they've got plenty of ammo to power any protracted downturn.

“Managers are definitely dialing down their equity risk,” said Mick Swift, chief executive officer at Abbey Capital, a $3.4 billion Dublin-based asset manager that allocates to such funds. “This is the first significant test in some time.”

Firms that use medium-term signals -- like Transtrend in the Netherlands, Quantica Capital in Switzerland and AlphaSimplex in Cambridge, Massachusetts -- say they've cut stock exposure but remain net long on equities.

“In our long book in European and U.S. equities we reduced some of the risk throughout the week, but it was all still very much in the margin,” said Daniel Schotanus, a strategy specialist at Transtrend, a $4 billion CTA in Rotterdam. “During these types of wild market moves, if you're going to do a lot of re-balancing, a lot of execution, it typically turns out to be very expensive and of course you contribute to the volatility.”

Mellon Investments' managed-futures strategy meanwhile, which uses shorter-term risk measures and lookback period, turned short equities last week.

The unique gyrations also served intraday momentum players well. The strategy notched gains as stock losses continued to snowball during the session, according to fund manager Berouz Fatemi who oversees a tail-risk strategy at Tages Capital.

“In general the horse is out of the barn by the time you trade,” Rob Croce, who runs managed-futures and risk-parity funds at Mellon, said from Boston. “Monetary policy doesn't allow markets to fall for very long so if you are ever going to be short, you better to do it quickly.”

The rout might have a silver lining for CTAs, whose popularity has waned as sleepy markets tranquilized by record-low rates hit returns. Trend-followers made their names in crisis-stricken 2008 by delivering a 13% gain. They dropped 4.8% last week, the most since February 2018, according to the SG CTA Index.

Systematic players that ride the market in either direction say they can make money in bear markets as long as the moves are sustained, at least in theory.

“If we start moving into that kind of environment, that's where CTAs should shine -- but it's very tricky,” said Nicolas Mirjolet, chief executive officer at Quantica Capital.

To contact the reporter on this story: Justina Lee in London at jlee1489@bloomberg.net

To contact the editors responsible for this story: Sam Potter at spotter33@bloomberg.net, Yakob Peterseil, Sid Verma

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