November 2019 - VIX Awakens from its slumber & Value marks its comeback - Systematic Fund Manager's Comments

6 December 2019

Emmanuel Hauptmann

The VIX (a measure of equity volatility) made headlines over the month having receded to record lows in tandem with U.S. and European equities reaching record highs amid record lows in global interest rates. The “fear gauge” remains well below its long-term average after posting its lowest close since August (11.30) — a decline that we believe is indicative of the growing complacency surrounding downside risks. But given the level of risk on the table, why were investors so complacent in November?

Well, just two days after the end of the month the VIX touched 17.99, up an astonishing 26.5% in just a 48-hour period (see chart below). Closing above its 200-day moving average for the first time since mid-October, it remains on track to test that month’s peak of 20.46. The move was largely attributable to disappointing data on U.S. manufacturing activity and a tweet by President Trump that underlined the scope for trade-related turmoil beyond U.S.-China talks.

Source: Bloomberg & RAM Active Investments

Meanwhile, speculative short bets on the VIX hit a record high, perhaps reflecting a fearful market away from the trade war. These bearish bets on stock volatility continue the narrative that beneath the veneer of record stock market highs for Europe and the U.S., the market is ripe for turmoil. We’ve discussed in last month’s editorial that there are many potential sources of volatility, from the U.S. protectionist push and Central Banks’ uncharted territory to a marked deceleration of global growth, but perhaps the most worrying is global debt levels. China’s default level has already equaled last year’s total ($17.1bn), a prime example of the credit tensions and corporate struggles. We remain highly cautious of portfolio level diversification as we move into 2020. Investors should also understand their exposure and liquidity levels amid the VIX’s reawakening.

Value back in fashion?

Value stocks have underperformed growth stocks for over a decade now. With growth stocks outperforming almost every other factor over recent years, largely explained by the performance of the technology and communication services sectors with so-called “FAANG” stocks (Facebook, Amazon, Apple, Netflix and Alphabet). The Growth style is typically in favour during periods when the economy is growing, while Value is popular when the cycle is at an end, as lower-valuation stocks tend to fall less than more expensive growth stocks.

What does this mean to our Strategies? Well, as per our chart below, within Europe, our Value style has benefitted from the nascent recovery of the factor in recent months. Given our ML Strategy has an intrinsic bias towards Value, it’s also positively benefited. The key indicator here is the amount of short covering in Cyclical industries relative to Defensive industries witnessed in recent months has reached extreme levels relative to the last few years. It remains to be seen whether Value can continue its recovery in the coming months and quarters.

Source: RAM Active Investments

Note: Table shown is for illustration purpose only. On the long-side sub-strategy performance is calculated based on simulated model portfolios rebalanced monthly on RAM equity investment screenings and may not represent the exact contribution of strategies in real portfolio. Strategy performance is adjusted considering their long-term theoretical fixed allocation in the fund. Performance is gross of management and performance fee. Client’s return will be reduced by such fees in case of investment in such strategies.

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