The size of the style risk move
Monday’s announcement of a “90% efficacious” vaccine from the Pfizer/BioNTech was the catalyst for the biggest 1-day mean reversion in growth vs value since 2009:
- The growth/value pair trade in Europe delivered (-16%) in a single day (Nov 9th) and another (-7%) the following day (Nov 10th)
- Monday’s move -16% for the style beta (-22% in the US) was the biggest on record (in 11 years)
Fig 1: Daily move (high beta growth vs high beta value)
- All of the gains of growth vs value as a style beta for the past 6 months were wiped out in a single day and in two days all of the COVID gains were wiped out
- Growth vs. Value is now back to June and March levels, already anticipating a normalisation of COVID in terms of impact on style biases
Fig 2: Growth vs Value YTD 2020
We have obviously been aware of the “positive vaccine headline news” being a genuine catalyst for this kind of move (hence our research effort in this space) together with potential for more significant US fiscal stimulus. Although the Pfizer vaccine efficacy is high and the timing a surprise, our view remains that mass vaccination will be “no silver bullet”: it will not eradicate COVID (it neither prevents virus transmission nor is it proven to work in the “vulnerable”) and even the bulls admit that mass vaccination is unlikely to be relevant until this time next year. We therefore face at least 6 months of sporadic lockdowns and infection suppression and therefore recession until any kind of normalisation is likely (even assuming mass vaccinations work)
The chances of significant US fiscal stimulus has also been significantly diminished by the failure of the Democrats to capture the Senate as expected (and ironically positive news of the forthcoming vaccine). So the chances that the global economy remains stuck in lockdown induced recessions remains high despite a vaccine being approved and 12 months is a long time to wait for evidence of normalisation in cash-burning industries.
Rather than being an opportunity to buy value and sell growth, we see it the other way. With hindsight it would have been better to de-risk more aggressively then fade the move on positive headlines. But now we’ve had the positioning wash-out already and it the recovery plays – not longer-term growth - that looks vulnerable to short-term disappointment now. We also believe that many of the trends like working from home and video conferencing have become habitual and will endure beyond COVID. There is a real risk of active investors getting whipsawed by a fad narrative.
What you should expect from our product:
Our stock selection process is based on “earnings surprise” rather than “growth” or “value”. We currently characterise our portfolio as having roughly equal weights to growth and value in both long and short books. As the process looks for earnings catalysts, we are mostly drawn to longs where trading momentum is strong and vice-versa. Hence many of our “value” longs like housebuilders are already trading well and don’t require a solution to COVID. Our remaining two vaccine shorts (“growth” shorts) were our only real winners in our short book on Nov 9th as their share prices collapsed on the likelihood if their vaccine candidates getting approved got even more unlikely owing to competitor success. If the market believes that COVID is “solved” then it will inevitably look to buy YTD COVID losers and sell winners, regardless initially of categorisation of “growth” or “value” or the longer term trading momentum. Hence, our style risk is subject to this “mean reversion” risk.
So whilst “earnings surprise” works most of the time, over the long term it can be subject to short, sharp set-backs (caused by positioning unwinds). Where the catalyst is potentially real (in terms of accelerating macro or easier money) there is scope for us to recognise this and position accordingly (e.g. April/May this year), but we are also aware that if we take on too much market beta our correlation will rise. We are flexible to incorporate some “recovery” trade in the portfolio but only if there is the potential for genuine earnings surprise with some evidence of duration. After the record two day move, much of the recovery opportunity and few of the risks, now seems priced in.
We have always marketed the product as “low correlation” rather than “low volatility” with the fund having a low correlation to market beta and therefore to most other funds. Our long-term record in delivering uncorrelated positive returns can be found here:
Clearly the risk from “double alpha” and hedging market beta is that – in contrast to the market - our most challenging times come when market beta performs strongly (as per Monday and Tuesday). It stands to reason that the fund performs at different times to market beta and therefore most other funds. The rough and the smooth of the product design need to be taken with the same equanimity, and its role as a portfolio diversifier fully understood. Throughout what has been a very good year for the product we have been asked about the timing of entry points into the strategy. If you believe in our process and value the diversification that the product gives away from market beta then we believe that the COVID vaccine “positioning washout” of the last two days should be a good entry point into the fund.
CEO and Fund Manager
Argonaut Capital Partners