Beta and Momentum – A Volatile Mix
Beta and Momentum are the two most volatile investment styles, based on Barra’s global long-term model (Figure 1). Yet they have a perhaps unintuitive relationship with each another: they have not only been negatively correlated historically, but lately they have moved even more starkly in opposite directions (Figure 2).
In one respect, this suggests that they could be natural hedges for one another. However, although our expectation is that the more recent trend of greater negative correlation persists, portfolio constructors should bear in mind that if this pattern breaks down then excessive exposure to these styles could amplify some unintended effects.
Figure 1. Annualised Volatility of Generic Barra Styles
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Source: MSCI Barra and Man Numeric; as of 31 March 2023.
Figure 2. Correlation Between Barra Momentum and Barra Beta
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Source: MSCI Barra and Man Numeric; as of 31 March 2023.
Diversified Financials – A Contradiction in Terms?
Contagion from March’s banking drama has fortunately been much less severe than may have been feared initially. Although the longer-term effects of potentially tighter credit conditions are still unknown, the nearer-term equity impact seems limited to financial sectors. As shown in Figure 3, the stocks that felt the strongest tremors from the regional-banking epicentre were most notably insurers, diversified financials, capital-markets businesses, and of course larger banks.
Looking at correlations to Barra Beta more broadly, it’s important to note that while all eyes have been on financials of late, investors should not get too myopically focused on what has been happening with recent bank failures. Perhaps more usefully for risk-management purposes, on the left we see the industries most negatively correlated with generic Beta; these include health services, health equipment, and food producers (Figure 4). This makes intuitive sense to us: demand for health care and food shouldn’t change amid headlines about bank runs (we can leave their correlation with each other for a discussion after we’ve digested our Easter confectionary).
Figure 3. Industry Factor Return Correlations with Regional Banks
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Source: MSCI Barra and Man Numeric; as of 31 March 2023.
Figure 4. Industry Factor Return Correlations with Beta (22-day Half-life)
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Source: MSCI Barra and Man Numeric; as of 31 March 2023.
Commercial Real Estate: The Next Domino?
As the banking crisis comes off a boil, in which sectors might the dominoes fall next?
Our view is that the commercial property sector could be at risk for two main reasons.
First, small- and medium-sized banks – that make up the bulk of US lenders – account for 70% of all commercial real estate loans.1 The collapse of SVB has forced these banks in particular to have a renewed focus on liquidity, inevitably resulting in a tightening in lending conditions.
Second, vacancy rates remain elevated since the pandemic (Figure 5): as working from home gained popularity, commercial tenants cut back on office space. A lack of demand could result in falling rents and thus lower commercial prices – which could further exacerbate problems if banks’ loan-to-value ratios balloon.
Figure 5. US Commercial Vacancy Rates Remain Elevated
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Source: Statista; as of November 2022.
With contribution from: Michael Dowd (Man Numeric, Head of Investment Risk) and Chao Xia (Man Numeric, Senior Quantitative Researcher)
1. Source: JPMorgan
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