What the ‘tech wreck’ doesn’t tell us about systematic investing

When the top US technology stocks tumbled 5% on June 9, analysts and investors were quick to point the finger at systematic momentum traders.
 
The stocks that performed the worst – notably Amazon, Apple, Facebook, Google and Microsoft – had displayed the fastest growing price gains over the past year. The faster the rate of increase, the more it reversed on the day.
 
This uniformity led some to conclude the sell-off was down to systematic momentum traders exiting their positions. But there are reasons to think such a hypothesis makes little sense.
 
Pointing the finger at quant funds could be missing the point, which is that discretionary investors increasingly influence factor performance by pre-empting systematic traders.
 
The idea of the tech wreck being largely about momentum originates from how a broader universe of stocks behaved on June 9. Mining stocks that had done particularly well sold off, while other mining stocks that had done less well went up. Individual stocks in sectors such as healthcare sold off sharply too. The clear defining element in what happened, as pointed out by the quant research team at Societe Generale in the wake of the sell-off, was price momentum.
 
However, that does not mean momentum investors were necessarily the episode’s driving force. Systematic trend-followers typically look at trends over a 12 month period, delaying the impact of short-term market gyration on their trading. Were that not the case, momentum investors would be reversing course all the time.

How factors are faring is more observable now, whereas in the past only specialist firms would have been tracking them

For similar reasons, risk parity funds – which weight investments based on volatility and have also been blamed for past market turbulence – also seem an unlikely trigger. The volatility of momentum stocks often spikes when those stocks reverse course. But risk parity funds track volatility over months, not days, so they are unlikely to have adjusted positions so quickly.
 
This leads to the question, if it wasn’t quant funds selling, who was? One possible answer lies in the growing enthusiasm for factor watching among discretionary investors.
 
Quants have always looked at the world in terms of factors. But non-quants are now becoming more aware of factor performance too, aided by the prevalence of factor-based smart beta products. How factors are faring is more observable now, whereas in the past only specialist firms would have been tracking them.
 
This is not to minimise the influence of systematic funds in events such as June’s. Most market participants think short-term momentum players had a hand in the selling once the episode was underway.
 
But discretionary investors might have played a key role. The implication for all investors – as recently argued by analysts at Bank of America Merrill Lynch – is that fear of a factor reversal could be critical in such a reversal taking hold.