The SPY-IWM Unwind, and Some Holes in the Beta Bucket

Taking a cue from the Renaissance conference call, in which Jim Simons stated that the main reason for RIEF's massive underperformance was the fatal positioning with regards to stock betas (long low beta stocks, short high beta stocks), Zero Hedge decided to analyze the performance of stock by beta bucket. For this exercise, betas of companies as calculated by their January 1 to March 6 performance was lumped into various buckets (<0.5;0.5-1.0;1.0-1.5;1.5-2;>2.0) and the subsequent relative price performance was mapped out from March 6 through today.

Now market purists will of course say that the data itself is self-referential as high beta stocks obviously will outperform; however, the point of the exercise is to demonstrate how quant funds (which track backward looking beta) use proprietary signals which look at near term past beta, and how a vast majority (especially in the 175/75 to 190/90 neighborhood) got trapped in the mysterious futures buying rally over the past several months, with a resulting blow out to their P&L.



As is painfully visible, any funds that ended up being short the high beta bucket, for example RIEF and other asset managers, got crushed recently. Now couple that with some pointed SEC sniffing around, a constant S&P futures bid, and some very angry investors after last Wednesday's conference call, and all of a sudden you may see some aggressive fleeing for the exits as a beta book gets unwound: high beta (garbage stocks) getting massively covered as low beta (utilities, healthcare) are sold off in droves to facilitate cash generation to satisfy redemption requests.

Throw in a little invisible SP futs buying and you get yourself the mother of all crap stock "bull" markets. Of course, the question of what happens once the forced unwinds end remains to be answered.

Also, we throw out the question, of just how peculiar is it that the Setauket fund's PBs (JPM and DB) are single-handedly dominating the demonstrated market in IWM trades today?



Lastly, juxtaposing a differental of IWM and SPY over the past few days, and one can see some further oddities: IWM is significantly underperforming the SPY since mid afternoon yesterday when the rally really took off in earnest. Was someone accidentally long SPYs and short IWMs and had to quickly readjust?



hat tip credit trader

Comments

[AJB7:]

How to weight a long-short portfolio is, of course, a perennial problem: beta, volatility, dollar, sectors, matrix correlations, etc. What I find hard to believe is that some hedge funds are simply shorting high beta, long low beta stocks, which unless I've missed something here, is just a market directional play, and in this case, one that was turned out wrong. I don't get it.

May 19 11:16 PM

[Michael Markov:]

For those of you who are interested I explained what had happened to RIEF in my recent blog post here:
markovprocesses.com/blog
It involves some delicate reverse-engineering of their returns and corroborates their statements in the call.

May 20 04:03 PM

[AJB7:]

Michael Markov wrote <For those of you who are interested I explained what had happened to RIEF in my recent blog post here:
markovprocesses.com/blog >

Thanks for the link. Your work looks interesting although I'm not sure why you would use MSCI EAFE alone for the proxy international exposure (which seems to me a rather gross investment index) rather than say, regional indices or ETFs. Realistically (leaving aside the US, fixed income, and commodities), I am currently long China and the Australian Dollar and neutral on Europe which I do not think is well captured in the MSCI EAFE. Indeed, I do not see how you can accurately capture a complex portfolio position using only four gross indices of any sort. But I admit I am a novice at style analysis and not well read in the area. Again, thanks.

May 20 09:21 PM

[Michael Markov:]

The EAFE index is intended to capture foreign equity sensitivity in RIEF positions -- whether these are ADRs or simply US stocks with significant foreign income. EAFE is sufficient for this purpose. I suggest that you read our entire 2007 research paper on RIEF mentioned in my blog. It provides background on style analysis and its applications. Thanks for looking at the blog.

May 21 07:13 AM