The median and percentile columns measure the performance of each factor in the Two Sigma Factor Lens relative to the entire history of the factor in USD, using weekly data for the period March 1, 1995 - March 20, 2020.

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Markets and Factor Performance Summary

• Global Equity markets continued their fall last week, starting with a notable -9% fall on Monday despite the U.S. Federal Reserve’s announcement of a full percentage point interest rate cut and the launch of a quantitative-easing program that would buy $700 billion worth of bonds and mortgage-backed securities.¹ Markets feared that this stimulus wouldn’t be enough to combat a potential recession resulting from the impacts of the coronavirus pandemic.
  • Other central bank activity was introduced throughout the week, including the European Central Bank announcing a €750 billion Pandemic Emergency Purchase Programme (PEPP)² and the Bank of England cutting rates and announcing a bond buying program.³
• In terms of currencies, the USD appreciated as investors treated the USD as generally safer than other currencies.⁴
  • The surge in the USD and the aforementioned Bank of England rate cut contributed to the GBP reaching lows relative to the USD not seen since the 1980s.⁵
  • This activity hurt the Foreign Currency factor and, to some extent, boosted the Foreign Exchange Carry factor, which has maintained a long position in the USD this year, as it was one of the highest-yielding currencies.
• Credit spreads in both investment grade and high-yield continued to widen, negatively impacting the Credit factor even after its residualization to the Equity and Interest Rates core macro factors.⁶
• Overall commodity performance was negative. Crude oil continued its decline, as Saudi Arabia and Russia extended their price war on the supply side.⁷ Gold suffered losses as well, despite a recovery on Friday, as investors sold the metal to generate cash and to meet margin calls in other assets.⁸ Some grains, such as wheat, provided slight relief with small gains.⁹
  • The Commodities factor, however, was effectively flat last week after its residualization, which is designed to isolate the marginal risk of changes in a diversified set of commodities prices from the risks shared with Equity, Interest Rates, and a G10 ex USD currency basket. In other words, the commodities index added little return beyond what was already explained by movements in equities, rates, and G10 currencies.
  • A note on residualization: 
    • The underlying index for the factor is the Bloomberg Commodity Index, which returned -6.4% last week. As mentioned above, the residualization removes the overlapping risk with:
      • The Equity factor. The Bloomberg Commodity Index has a recent beta to the Equity factor of approximately 0.5. In the residualization process, the factor removes 50% of the Equity factor’s -10.26% return last week, or approximately -5.1%.
      • The Interest Rates factor. The index has a recent beta with the Interest Rates factor of approximately -0.4. The factor removes -40% of the Interest Rate factor’s -0.65% returns last week, or approximately 0.3%. 
      • A G10 ex USD currency basket (to neutralize any currency effects, since commodities are typically priced in USD). This currency basket returned -2.3% last week (see notes on USD appreciation above).
    • Subtracting the -5.1% from the residualization to Equity, the 0.3% from Interest Rates, and the -2.3% from currency movements from the commodities index results in a nearly flat return coming from distinct Commodities risk.¹⁰

• Notable hedge fund liquidations, especially across Equity Long/Short and Quant funds, were observed last week as fund managers deleveraged and covered shorts.¹¹ This activity likely had an impact on the equity style factors. Two factors in particular exhibited notable divergence: Quality and Low Risk.
  • These two factors historically have a positive 0.4 correlation, as low-risk companies, as defined by those with stocks that have lower residual return volatility and lower equity betas, tend to overlap with high-quality companies, as defined by those with low leverage and high profitability, for example. However, over the YTD period, the two factors have exhibited a -0.6 correlation.
  • Quality posted gains last week, returning 2.69%, in what we believe is supported by a flight to quality move by investors. The factor was boosted mostly by its Earnings Quality and Leverage components.
  • Low Risk continued its sell off, suffering over 11%, driven by both of its components (described above). This can happen when markets sell off indiscriminately as low-beta stocks can underperform what their betas might suggest due to beta compression. Further, the factor relies on trusting your risk model, and “knowing” which stocks are low or high beta. Not being able to trust your risk model in this type of environment may lead investors in this strategy to unwind low-risk stock bets.

REFERENCES

¹Source: CNBC article “Federal Reserve cuts rates to zero and launches massive $700 billion quantitative easing program” on March 15, 2020.

²Source: European Central Bank press release on March 18, 2020.

³Source: CNBC article “Bank of England cuts rates again and ramps up bond buying to combat coronavirus impact” on March 19, 2020.

⁴Source: CNBC article “A global rush into the US dollar is driving extreme market moves and a temporary shortage” on March 19, 2020.

⁵Source: Trading Economics.

⁶Source: FRED ICE BofA US High Yield Index Option-Adjusted Spread and ICE BofA US Corporate Index Option-Adjusted Spread.

⁷Source: Forbes article “Oil Plummets 24% As Saudi Arabia Doubles Down On Price War With Russia” on March 18, 2020.

⁸Sources: CNBC article “Gold rises on safe-haven appeal but set for weekly drop” on March 20, 2020 and Forbes article “Why The Gold Slump In A Bear Market?” on March 22, 2020.

⁹Source: Trading Economics.

¹⁰The residualized Commodities factor, in addition to other residualized macro factors, is also scaled to a volatility of 7%. It calculates the betas to the other factors using a weighted regression over a 3 year period with a half-life of 6 months.

¹¹Sources: Financial Times article “Hedge fund bets hammered as industry retrenches amid cash dash” on March 19, 2020 and CS Prime Services Risk Advisory.

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