(Bloomberg) -- Quant funds that chase the hottest trades on Wall Street are getting thrashed as momentum bets backfire all at once.
Going into July, trend followers were positioned for the year’s big trades to keep gathering momentum: They were plowing into stocks, betting against developed-nation government bonds and counting on the yen to keep weakening, according to Societe Generale SA.
Then each of those markets moved sharply in the wrong direction, hitting them with deep losses. By one broad measure of the group, nearly all of this year’s gains were wiped out.
“Everything went wrong at the same time,” said Andrew Beer, founder of Dynamic Beta Investments, whose iMGP DBi Managed Futures Strategy ETF is down some 7% in August, slashing its returns to about 5% this year.
“This is a classic cross-asset reversal,” he said. Most of the funds “have given back anywhere between half to three quarters of their gains year-to-date within the past few weeks.”
The reversal-of-fortune is underscoring the inherent risks in a strategy that proliferated during the recent bout of market calm — and likely added fuel to recent swings as investors unwound crowded trades.
The trend-chasing strategy, which almost by design is exposed to rapid shifts in sentiment, had paid off for months as the US economy powered past the Federal Reserve’s high rates, AI euphoria kept fueling the stock bull run, and the yen was deflated by the Bank of Japan’s loose monetary policy. But it was upended over the past few weeks, when the yen rallied, the BOJ hiked rates and a slowdown in the US job market rekindled recession fears.
Markets have mounted a choppy recovery from Monday’s rout, but it hasn’t been nearly enough to offset the toll. After a strong start of the year that left the cohort up by 12% at the end of April, they have since swung to a gain of just 0.2% in 2024, according to the Societe Generale CTA Index.
“The repricing of the growth and interest-rate outlook at the end of June, coupled with the most recent concerns around US data created a sharp reversal,” said Sandrine Ungari, head of cross-asset quant research at Societe General. “This strong performance at the start of the year was mainly due to the upward trend in equities and commodities prices.”
The diversified cohort, known as commodity trading advisers, typically ride the momentum of futures markets of all stripes to harness the wisdom of the investing crowd.
The quants who use long-term and mid-term time horizons for their trades have been hardest hit by the recent turn, according to Dynamic’s Beer. Short-term funds, which seek to ride trends over the course of a few days, are down only 2.7% since the end of April compared with a 10.4% to the broader cohort, according to the SocGen index.
Systematic funds of all stripes have been forced to shed stocks and buy bonds at a frenetic pace in the latest rout, likely exaggerating the market moves.
The cohort has sold $61 billion of global stocks and bought $205 billion of bonds from major developed countries in the past two weeks alone, according to a analysis by Nomura Securities International.
Even as the cross-asset turmoil calmed on Tuesday and Wednesday, the recent volatility signals cracks in the Wall Street consensus and creates difficulties for funds trying to seize on clear market trends.
“By definition they need trend,” said Charlie McElligott, a cross-asset strategist at Nomura. “They ultimately are built to profit from the ability to monetize these breaks. But it’s the choppy trend reversal markets which reduce the opportunity set for them.”
--With assistance from Vildana Hajric.
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