October volatility – how did your managers trade?
October was a volatile month for equity markets. It featured average daily swings in the SPX of 95 basis points. Not only does that make October the most volatile month in 2014 by a whopping 45%, it’s the most volatile month in more than two years (June, 2012).
Even though the realized volatility was so high, the market followed a symmetrical v-shape pattern which we highlight in the introductory piece of this series. The S&P 500 swooned to an intraday low of 1820 on October 15th, before rallying to close at historical highs; up 2.44% for the month. This is a strong return if you were willing to ride through the turbulence. International markets moved in a correlated fashion, with the FTSE All World (USD hedged) mirroring that shape.
This type of market movement is a ripe opportunity for an active manager to capture excess risk-adjusted return by managing exposures and trading opportunistically. It can also be a source of underperformance. Managers can capture alpha in this type of market environment with trading strategies including:
- Attempting to time the market by reducing net exposure on the way down and increasing it on the way up.
- Trading macro/hedge instruments in an attempt to nullify the market effect from core positions.
- Opportunistically trading core positions by “buying the dip” on perceived weakness.
- Capturing dispersion by delta-hedging warped correlations.
Putting on my allocator hat, I would want to ask my active manager about their trading and exposure mentality during the month, as a gauge for how it may have effected performance at a portfolio and security level. At a bare minimum, I want to know if her returns suffer in periods of volatility, or if they add value during instability. As a manager, I would want to autopsy the result of my intra-month decisions to understand if I added/detracted value, or exhibit behavioral biases introduced by stressful market conditions.
At Novus, we provide our clients tooling to help unpack these questions, with simulations like no-turnover portfolio performance versus realized performance, and static average exposure portfolios versus actual moves. All of this is to ultimately help isolate which active skills are driving alpha.
Case in point: Cheniere Energy, Inc. (NYSE: LNG), a heavily trafficked security which saw disproportionate intra-month volatility. Our Hedge Fund Universe (“HFU”) captures 82 managers filing the security, represented $5.5bn of ownership, or 2,400% of average daily volume. These owners were frantically re-calibrating their price targets with the downward slide of crude oil. Average trading volume for the first nine months of the year stood at just under 3 million shares a day, while more than 5.1 million shares of LNG changed hands each day in October.
The stock also followed a similar V-shape pattern that we noted before with the broader equity markets, as Cheniere dropped over 21% in 10 trading days, only to rally 21% and end the month slightly down.
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