Quants Corner - The pandemic’s legacy: More thumbs on more scales

The pandemic’s legacy: More thumbs on more scales

With economic growth hammered globally in March, April and May by the COVID-19 pandemic, investors have been on the lookout for – and hopeful about – a V-shaped economic recovery. 

This has, so far, proved elusive. But there is one ‘take off’ story – government rules and regulations. Stressful times demand a response, and authorities are usually quick to roll out temporary measures. But, as Nobel laureate Milton Friedman famously observed, “Nothing is so permanent as a temporary government program.”

For investors, factoring the impacts and expected longevity of these measures into their outlooks for countries, sectors and industries can be a tedious, time-consuming task. Rent freezes or moratoriums, for instance, are playing out differently is a wide range of real estate markets. But the process can be facilitated by using EPFR data, both as a stand alone metric and in conjunction with other datasets.

Taking a sector-based approach

To illustrate this, we can look at sectors through several of the windows that EPFR’s data opens to get a sense of where and when today’s temporary rules may become the new normal for some sectors and reshape their investment cases.

A good place to start is the relative weight – reflected in flows to dedicated funds – that investors are assigning to different sectors.

In the United States, where regulatory interference is viewed as less likely to occur and less likely to endure if it does, Technology and Healthcare/Biotech Sector Funds have recorded significant inflows year to date, whereas Financials and Real Estate Sector Funds have seen outflows (see chart below). It is worth noting that this divergence in flows to different Sector Fund groups generally mirrors the relative performance of different sectors in the US.

Figure -1a, US Sector Fund Flows by mandate, EPFR 

In Europe, flows to healthcare mandated funds have outpaced those to other groups (see chart below), with Europe Financial Sector Funds well to the back of the pack. But Technology and Real Estate Sector Fund flows have not followed the pattern being experienced by their US counterparts.

Figure -1b, Europe Sector Fund Flows by mandate, EPFR

Dropping down a level

Using EPFR’s Stock Allocation database, we can also get a stock-level window into evolving perceptions towards individual sectors.

The Stock Allocations database tracks the aggregate (and individual) positioning of funds for individual stocks. We can then compare these positions at the sector level with other sector-level data.

Table-1 and Table-2 below rank the increases and decreases at the sector level for stock allocations within US and European sectors. In contrast to the fund flow data, there is more unanimity between the US and Europe when utilizing this dataset.

Table -1 – US Sectors, Stock & Fund Level Allocations - % of Holders being Positive or Negative on Sectors

Table -2 – Europe Sectors, Stock & Fund Level Allocations - % of Holders being Positive or Negative on Sectors

Healthcare and Information Technology are the most ‘added to’ sectors in the EPFR Stock Allocation database for both European and US stocks while Real Estate, Consumer Discretionary, Financials and Energy plays have seen the biggest decease so far this year.

A short foray into hedge fund data

Utilizing hedge fund data from EPFR partner Caretta, we get another view at the sector level. In this case, the hedge fund positioning data provided by Caretta is in line with the allocations by mutual fund managers.

For instance, Caretta’s data on daily short positions at the share level shows that Real Estate stocks are the most shorted European stocks in terms of the average percentage of outstanding shares. Energy is the second most shorted sector while Utilities, Telecom and Financials are among the least shorted sectors at the moment.

Figure -2 European Sector Level Short Positions, Caretta Short Position Database

Looking ahead through multiple lenses

Multiple angles usually provide a clearer – and more investible --- picture of overall positioning in a given market.

When an idea is embraced by only a few investors, the signal that sends is more likely to be a speculative one. But when a larger investor group opts to invest in similar ideas or themes, it increases the likelihood that the signal is a longer-term one.

Amidst a rapidly changing regulatory landscape, active mutual fund portfolio managers and fund investors on both sides of the Atlantic agree that the healthcare sector numbers among the most promising sectors. But investors focused on Europe see a brighter future for real estate than do their US counterparts, which may be a reflection of their expectation that market forces will be allowed to visit more creative destruction on the US market.

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