Excerpt
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).
Visit ExtractAlpha to read about the Common Risk Factors and Technical Factors (Tactical Model, Factor Momentum, and Residualized Reversal):
https://extractalpha.com/2020/04/08/what-happened-to-the-quants-in-march-2020
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