The global equity desk at Merian Global Investors runs its funds using a medium-term investment process. It has in place specific risk parameters to mitigate the effects of sharp market rotations and volatility. Those aspects of our investment process which have experienced the most marked reaction to the recent deterioration in the investment universe have been our market environment indicators. Currently these reflect weakness in investor sentiment, with all regions retracing to pronounced pessimistic states. Similarly, cross-sectional volatility for North America, Asia Pacific and Europe is now firmly anchored in a high risk state.
The past few weeks were characterised initially by a prolific deleveraging across all asset classes, followed lately by an exhaustion-led rally. In equities, there have been significant moves to intra-sector single stock dispersions and to meaningful sectoral dispersions. Initially, REITs and other bond proxies experienced particular selling pressure, seen as risk management as market participants wrestled with the economic impact of the Covid-19 crisis.
More recently, the exhaustion-led rally of Monday 23 March through Wednesday 25 March saw defensives underperform relative to cyclicals. Meanwhile, value has outperformed growth, wrong-footing many who had positioned for defensives to hold up.
The magnitude of the market activity has spilled over into factor returns. Significant factor sell-offs, predominantly within North America and Europe, had a meaningful negative impact across most factor sets. This was particularly pronounced in the funds’ company management factor, detracting from performance. In part this was due to the reappraisal of share buybacks by many companies, as the economic fall-out from Covid-19 leads to redeployment of corporate capital. Up until this point the funds had enjoyed relatively stable NAV movement relative to peers. However, the extent of the latest sell off at a factor level has weighed on their recent returns.
The indiscriminate nature of the market sell off led to a number of ‘hedged positions’ within the portfolios providing less mitigation than they have done in previous recent sessions. At the portfolio level the funds were negatively impacted by overweight exposure to certain industries within the utilities sectors, specifically electric utilities and independent power and renewable electricity producers. This may be explained by the initial selling pressure on bond proxies referred to above. Another recent detractor was the funds’ overweight to metals and miners. Meanwhile, the allocation to insurance companies, which sold off on concerns around mounting insurance liabilities arising from the Covid-19 crisis, was only marginally offset by the underweight or short exposure to banks in both funds. This was reflected by the increased range in the NAV of the funds at various pricing points from the start of the week of 23 March.
Reassuringly, in the past few sessions, we have begun to witness meaningful diversification from a variety of the funds’ underlying subcomponents; for example, during the most recent risk-off episode, from the quality component subcomponent within the funds’ dynamic valuation factor. We have seen an uptick in enquiries concerning our medium-term factor forecasting, given the growing consensus that the extensive deleveraging experienced in this space over the past 18 months may finally be flattening out. By contrast, other investment strategies may have only begun to experience the first effects of de-grossing and deleveraging.