Merrill Let Loose On The Quant Scent

In a report released yesterday, it is somewhat gratifying that Merrill Lynch analyst Mary Ann Bartels agrees with Zero Hedge conclusions about possible near-term market volatility events as a result of quant fund deleveraging.

Estimated quant HF market exposure falling sharply

Last week, we noted that our estimate of hedge fund exposure based on factor based analysis suggested L/S HF market exposure may have peaked in the second half of March (top left chart below), after increasing significantly from the record lows of mid-December, and the sharp rise in large speculators’ net long position in S&P 500 futures was a possible hedge. The reduction in market exposure is even more evident among quantitative funds (top right and bottom left charts). Quant fund market xposure appears to have peaked in Feb, but started to fall rapidly in late March, a couple of weeks into the current equity rally. Quant funds, not surprisingly, are down ~-1.9% over the last month. US L/S equity funds have been able to capture more of the month-long move up in equities, gaining 1.3%. But both categories of funds are now pulling back.

The reduction in market exposure may be in part due to quarter-end rebalancing of books, but the readings could be important for two reasons. First, a sharp fall in beta could be a contrarian bullish for equities if HFs are forced back in. Secondly, HFs are an important source of liquidity for the markets – particularly true of quant funds employing high-frequency algorithmic and programming trading strategies. A big drop in HF presence in the equity markets could result in rising volatility.


Significant estimated factor exposures for Equity Market Neutral funds:

  • M/N funds’ market exposure further underweights equities.
  • Growth, large caps and high quality tilts. Positive inflationary expectations.

Significant factor exposure changes since last week:

  • Market exposure continues to decline rapidly.
  • Large caps and High quality tilts rise. Inflationary expectations increase.


And lastly, another chart, this time depicting the Dow Jones Equity Market Neutral Index (DJHFEQMK). Not lookin’ too hot.


Originally published at the Zero Hedge blog and reproduced here with the author’s permission.

One Response to "Merrill Let Loose On The Quant Scent"

  1. Eric   April 16, 2009 at 5:46 am

    Fascinating article – thank you! I am going back to all the related posts at rgemonitor & jessescrossroadscafe to educate myself further.I know this is the stupidest question to ask, but how to profit from this knowledge? With volatility working both ways, is there a trade with high degree of probability for success? Could you comment on UYG or FAZ as probable’s ?Thank you in advance for your time,Regards,Eric