What happened to the quants in March 2020?

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In March, a wild month in the markets, most of the factors we track – across sentiment, digital, and especially factor momentum – outperformed, while simple reversal strategies had their worst intra-month returns in recent history before rebounding massively in the last half of the month.  What happened?

Here we dig into the returns of several factors to uncover some of the drivers of the month’s quant performance, and offer a few possible explanations.

 

Basic Reversal

Below is a simple chart of dollar neutral gross returns of equally weighted portfolios, based on going long and short the extreme deciles of trailing 5-day return reversal, rebalanced daily, in developed markets.  This is just about the most basic “stat arb” strategy you can run, and while it’s not a great strategy of course, it does represent a boiled down version of what underpins a lot of mid frequency stat arb reversal.

Check out that Y axis.  This is just long minus short without additional leverage!

Just to put the magnitude of this drawdown into context, here’s the same chart for the US, going back over time:

And here are the daily returns’ Z scores, using an expanding window to calculate the average and standard deviation.  The 17th and 18th were 10-standard-deviation negative events, and the 19th was a 20-standard-deviation positive event, even after taking into account all previous days’ moves including August 2007, the first 10+ standard deviation event on the graph (you can see my article about the 2007 Quant Crisis here).  That’s pretty nuts!

Common Risk Factors

Meanwhile, what was going on with common fundamental factors during last month in the US?  Here are the returns to the factors in the ExtractAlpha Risk Model for the US:

Factor returns in Europe performed similarly: (we also cover Asian markets)

Both U.S. and Europe experienced relatively big moves, with Momentum outperforming strongly and Value-type factors underperforming.

It’s also worth mentioning that the big dislocation in these factors, and the bottom in the Reversal charts, occurred on March 18th, whereas markets didn’t bottom until the 23rd.

Technical Factors (Tactical Model, Factor Momentum, and Residualized Reversal)

Notably, these factors were all trending, with their daily returns strongly positively autocorrelated.  In fact, ExtractAlpha’s Factor Momentum score, which is a component of our Tactical Model – a model focused on technical dynamics – is designed explicitly to capture these factor trends, and as a result it performed very strongly during these trends, albeit with a single-day drawdown on the 19th (immediately after the factor dislocation and reversal drawdown ending on the 18th).

Our Tactical Model also has a Reversal Component to it, which despite being a bit more sophisticated than the basic reversal model – it takes into account risk factor exposures by looking for reversals in returns which have been residualized to our risk factors and industries for example – performed similarly.

Overall however, our Tactical Model experienced far less volatility as a result of the strategy’s diversification; in addition to Reversal and Factor Momentum, our Tactical Model also captures Liquidity Shocks and Seasonality, a total of 4 components.

In Europe, monthly performance for the month of March was even stronger, with the Factor Return Component returning 36% and the overall Tactical Model returning 14%!

Our view on what happened

So, factors were trending, and stocks which appeared otherwise similar in risk profile but had divergent returns had their returns drift apart over the first half of March rather than mean-revert as they usually did.

One reasonable explanation is that there’s a latent “COVID-19” risk factor, not included in any conventional risk models, and that this factor – like other common factors – was trending.  So the reason those otherwise similar stocks diverged was that they differed in exposure to the COVID-19 factor and that factor itself had a large drawdown followed by a rebound; a reversal strategy conditioned on this factor wouldn’t have made the trades shown in the reversal strategies above.  Most likely the majority of quant players hadn’t quantified a COVID-19 factor in time for March, though it’s possible that more statistical methods (such as a quickly-evolving principal components-based statistical model) may have.

A different, but not mutually exclusive, explanation is that the large drawdowns across asset classes and strategies (including stat arb itself) in early March triggered selling in liquid strategies generally, as funds anticipated redemptions and decided to sell and lock in their losses – without knowing which day would be the bottom and whether there would be a quick snap-back.  With multiple funds selling off their portfolios, and with those portfolios being correlated (i.e., holding similar stocks) because their strategies are correlated (i.e., trading similar alpha models), there was downward pressure on their longs and upward pressure on their shorts, and a domino effect across portfolios which employed the crowded reversal trade.  This explanation is essentially identical to the August 2007 one.  However, the big March drawdown and subsequent snap back seem to be at least somewhat more narrow in the sense that other common quant factors (including Momentum and Value – to the extent that hedge fund quants still trade Value after ten years of underperformance) didn’t show the same pattern; in ‘07, most common factors did, to some extent.

Either way, it seems that the first half of the month did have severe effects on some quant funds, generally negatively for stat arb and, anecdotally, positively for some HFT and trend-following CTA strategies.  We aren’t basing this on any private information, but on publicly available articles like this about Point72, this one about Schonfeld, this one mentioning OxAm and RenTech in addition, this one about DE Shaw’s stat arb fund, and some contacts’ responses to my LinkedIn post from the middle of the event here mentioning Ronin Capital and others.

Performance from our alternative data models

Meanwhile, how about the alternative data factors we track in our other models?  They were generally very strong across both U.S. and Europe. These include Cross Asset Model (options market sentiment), Digital Revenue Signal (digital demand), and TRESS (blogger sentiment), in addition to Tactical Model and risk factors in ExtractAlpha Risk Model previously mentioned.

These factors – based on very different concepts and data sources – were all unaffected by the stat arb liquidations, because they aren’t crowded; as we’ve been urging quants since our founding in 2013, especially in light of the August 2007 event, quants need to diversify their alpha sources.  That seems even more obvious now, but it is surprising that even in 2020 quants continue to be exposed to crowded, price-based trades when there are now quite a few proven, diversifying alternative data-based quant factors available in the market.

When the dust settles from the recent market turbulence, we expect that these unique alpha sources will attract a lot of attention.

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Alan Kwan

Alan joined ExtractAlpha in 2024. He is a tenured associate professor of finance at the University of Hong Kong, where he serves as the program director of the MFFinTech, teaches classes on quantitative trading and big data in finance, and conducts research in finance specializing in big data and alternative datasets. He has published research in prestigious journals and regularly presents at financial conferences. He previously worked in technical and trading roles at DC Energy, Bridgewater Associates, Microsoft and advises several fintech startups. He received his PhD in finance from Cornell and his Bachelors from Dartmouth.

John Chen

John joined ExtractAlpha in 2023 as the Director of Partnerships & Customer Success. He has extensive experience in the financial information services industry, having previously served as a Director of Client Specialist at Refinitiv. John holds dual Bachelor’s degrees in Commerce and Architecture (Design) from The University of Melbourne.

Chloe Miao

Chloe joined ExtractAlpha in 2023. Prior to joining, she was an associate director at Value Search Asia Limited. She earned her Masters of Arts in Global Communications from the Chinese University of Hong Kong.

Matija Ratkovic

Matija is a specialist in software sales and customer success, bringing experience from various industries. His career, before sales, includes tech support, software development, and managerial roles. He earned his BSc and Specialist Degree in Electrical Engineering at the University of Montenegro.

Jack Kim

Jack joined ExtractAlpha in 2022. Previously, he spent 20+ years supporting pre- and after-sales activities to drive sales in the Asia Pacific market. He has worked in many different industries including, technology, financial services, and manufacturing, where he developed excellent customer relationship management skills. He received his Bachelor of Business in Operations Management from the University of Technology Sydney.

Perry Stupp

Perry brings more than 20 years of Enterprise Software development, sales and customer engagement experience focused on Fortune 1000 customers. Prior to joining ExtractAlpha as a Technical Consultant, Perry was the founder, President and Chief Customer Officer at Solution Labs Inc. a data analytics company that specialized in the analysis of very large-scale computing infrastructures in place at some of the largest corporate data centers in the world.

Perry Stupp

Perry brings more than 20 years of Enterprise Software development, sales and customer engagement experience focused on Fortune 1000 customers. Prior to joining ExtractAlpha as a Technical Consultant, Perry was the founder, President and Chief Customer Officer at Solution Labs Inc. a data analytics company that specialized in the analysis of very large-scale computing infrastructures in place at some of the largest corporate data centers in the world.

Janette Ho

Janette has 22+ years of leadership and management experience in FinTech and analytics sales and business development in the Asia Pacific region. In addition to expertise in quantitative models, she has worked on risk management, portfolio attribution, fund accounting, and custodian services. Janette is currently head of relationship management at Moody’s Analytics in the Asia-Pacific region, and was formerly Managing Director at State Street, head of sales for APAC Asset Management at Thomson Reuters, and head of Asia for StarMine. She is also a board member at Human Financial, a FinTech firm focused on the Australian superannuation industry.

Leigh Drogen

Leigh founded Estimize in 2011. Prior to Estimize, Leigh ran Surfview Capital, a New York based quantitative investment management firm trading medium frequency momentum strategies. He was also an early member of the team at StockTwits where he worked on product and business development.  Leigh is now the CEO of StarKiller Capital, an institutional investment management firm in the digital asset space.

Andrew Barry

Andrew is the CEO of Human Financial, a technology innovator that is pioneering consumer-led solutions for the superannuation industry. Andrew was previously CEO of Alpha Beta, a global quant hedge fund business. Prior to Alpha Beta he held senior roles in a number of hedge funds globally.

Natallia Brui

Natallia has 7+ years experience as an IT professional. She currently manages our Estimize platform. Natallia earned a BS in Computer & Information Science in Baruch College and BS in Economics from BSEU in Belarus. She has a background in finance, cybersecurity and data analytics.

June Cook

June has a background in B2B sales, market research, and analytics. She has 10 years of sales experience in healthcare, private equity M&A, and the tech industry. She holds a B.B.A. from Temple University and an M.S. in Management and Leadership from Western Governors University.

Jenny Zhou, PhD

Jenny joined ExtractAlpha in 2023. Prior to that, she worked as a quantitative researcher for Chorus, a hedge fund under AXA Investment Managers. Jenny received her PhD in finance from the University of Hong Kong in 2023. Her research covers ESG, natural language processing, and market microstructure. Jenny received her Bachelor degree in Finance from The Chinese University of Hong Kong in 2019. Her research has been published in the Journal of Financial Markets.

Kristen Gavazzi

Kristen joined ExtractAlpha in 2021 as a Sales Director. As a past employee of StarMine, Kristen has extensive experience in analyst performance analytics and helped to build out the sell-side solution, StarMine Monitor. She received her BS in Business Management from Cornell University.

Triloke Rajbhandary

Triloke has 10+ years experience in designing and developing software systems in the financial services industry. He joined ExtractAlpha in 2016. Prior to that, he worked as a senior software engineer at HSBC Global Technologies. He holds a Master of Applied Science degree from Ryerson University specializing in signal processing.

Jackie Cheng, PhD

Jackie joined ExtractAlpha in 2018 as a quantitative researcher. He received his PhD in the field of optoelectronic physics from The University of Hong Kong in 2017. He published 17 journal papers and holds a US patent, and has 500 citations with an h-index of 13. Prior to joining ExtractAlpha, he worked with a Shenzhen-based CTA researching trading strategies on Chinese futures. Jackie received his Bachelor’s degree in engineering from Zhejiang University in 2013.

Yunan Liu, PhD

Yunan joined ExtractAlpha in 2019 as a quantitative researcher. Prior to that, he worked as a research analyst at ICBC, covering the macro economy and the Asian bond market. Yunan received his PhD in Economics & Finance from The University of Hong Kong in 2018. His research fields cover Empirical Asset Pricing, Mergers & Acquisitions, and Intellectual Property. His research outputs have been presented at major conferences such as AFA, FMA and FMA (Asia). Yunan received his Masters degree in Operations Research from London School of Economics in 2013 and his Bachelor degree in International Business from Nottingham University in 2012.

Willett Bird, CFA

Prior to joining ExtractAlpha in 2022, Willett was a sales director for Vidrio Financial. Willett was based in Hong Kong for nearly two decades where he oversaw FIS Global’s Asset Management and Commercial Banking efforts. Willett worked at FactSet, where he built the Asian Portfolio and Quantitative Analytics team and oversaw FactSet’s Southeast Asian operations. Willett completed his undergraduate studies at Georgetown University and finished a joint degree MBA from the Northwestern Kellogg School and the Hong Kong University of Science and Technology in 2010. Willett also holds the Chartered Financial Analyst (CFA) designation.

Julie Craig

Julie Craig is a senior marketing executive with decades of experience marketing high tech, fintech, and financial services offerings. She joined ExtractAlpha in 2022. She was formerly with AlphaSense, where she led marketing at a startup now valued at $1.7B. Prior to that, she was with Interactive Data where she led marketing initiatives and a multi-million dollar budget for an award-winning product line for individual and institutional investors.

Jeff Geisenheimer

Jeff is the CFO and COO of ExtractAlpha and directs our financial, strategic, and general management operations. He previously held the role of CFO at Estimize and two publicly traded firms, Multex and Market Guide. Jeff also served as CFO at private-equity backed companies, including Coleman Research, Ford Models, Instant Information, and Moneyline Telerate. He’s also held roles as advisor, partner, and board member at Total Reliance, CreditRiskMonitor, Mochidoki, and Resurge.

Vinesh Jha

Vinesh founded ExtractAlpha in 2013 with the mission of bringing analytical rigor to the analysis and marketing of new datasets for the capital markets. Since ExtractAlpha’s merger with Estimize in early 2021, he has served as the CEO of both entities. From 1999 to 2005, Vinesh was the Director of Quantitative Research at StarMine in San Francisco, where he developed industry leading metrics of sell side analyst performance as well as successful commercial alpha signals and products based on analyst, fundamental, and other data sources. Subsequently, he developed systematic trading strategies for proprietary trading desks at Merrill Lynch and Morgan Stanley in New York. Most recently he was Executive Director at PDT Partners, a spinoff of Morgan Stanley’s premiere quant prop trading group, where in addition to research, he also applied his experience in the communication of complex quantitative concepts to investor relations. Vinesh holds an undergraduate degree from the University of Chicago and a graduate degree from the University of Cambridge, both in mathematics.

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