July 4th 2024, Allison Yang, Weichuan Deng
This blog provides a mid-2024 update on the current state of the equity market neutral (EMN) fund space. We review the relative risk and performance profiles of prominent quant peers including JMNAX, QMNNX, and VMNFX, alongside QMIT’s flagship market neutral strategy. EMN funds aim to deliver market-neutral returns by balancing long and short positions in equities, thereby minimizing market exposure and focusing on stock selection skills. These funds are designed to achieve consistent returns regardless of the market direction, making them an attractive option for investors seeking stability and a better risk-adjusted profile than long only funds which are fully beta exposed.
QMIT's HEDGE FUND IN A BOX -- Background & peers
The QMIT "HEDGE FUND IN A BOX" (HFIB) index is a fully risk-optimized equity market neutral hedge fund portfolio accessible via bank swaps or structured products. Published daily (5.5Y LIVE), it is based on the flagship Sizzling Seven composite multi-factor model. The Sizzling Seven signal is constructed by combining 18 machine learning Enhanced Smart Betas (ESBs) via ensemble learners. The composite signal benefits from diversification across uncorrelated ESBs and exposure to exotic risk premia on the most liquid ~3000 North American stocks and ADRs. Figure 1, shows the Sizzling Seven composite MFM underlying HFIB with its constituent ESBs and sub-composites like Quality, Value, GrowthMo etc. The benefits of diversifying across uncorrelated smart betas are evident. The HFIB risk-optimization setup ensures dollar and beta neutrality while controlling for earnings torpedoes and meme stock squeezes in order to deliver a higher risk adjusted outcome. QMIT also neutralizes the most common 5 naive factors in order to accentuate the idiosyncratic alpha. While there does exist 24.5Y of HFIB history (including 19 years of back-tested returns from 2000-2018), for the purposes of this study we only focus on the 5.5Y LIVE daily published returns (based on either a daily or a weekly rebalance) for HFIB & peer funds. QMIT’s HFIB strategies are (both daily and weekly rebalanced) inclusive of transaction costs and short rebates but gross of fees (as is the norm for an index). The three prominent peers used for this study are:
JMNAX (JPMorgan Market Neutral Fund)
QMNNX (AQR Market Neutral Fund)
VMNFX (Vanguard Market Neutral Fund)
Figure 1: ESBs and Combo VAMI
Transaction Cost & Turnover
Historical price data and daily portfolio weights are based on a T-1 convention. To avoid look-ahead bias we assume trading on T+0 using the alphas available on T+0 based on the T-1 closing prices and fundamentals (the formation date). Further, for the QMIT strategies we assume all executions are done at the close at a rate of 5 mills (i.e., $0.0005/ share) on an AUM of $100 million. The average daily transaction cost estimate is based on the 6-month period [January 2021 through June 2021] which is then annualized in basis points of AUM.
Table 1: Daily and Weekly Rebalance Transaction Cost
Turnover is defined as the 4-way absolute sum of shares traded on the assumed $100 × $100 million exposure & underlies the corresponding tcost estimates shown above. As one might expect, daily rebalancing results in a 2.5x higher daily flip rate of over 105% (4-way) of AUM while the imputed daily turnover in the weekly case is much lower at only 40%. The annualized turns are high but consistent with the profile of active quant equity strategies in the space.
Daily Rebalanced Turnover: 105.2% per Day vs 26,510% Annualized (265x/ y)
Weekly Rebalanced Turnover: 40.25% per Day vs 10,130% Annualized (101x/ y)
Figure 2: Daily Return VAMI
Figure 3: Monthly return - VAMIs (Sandbox)
Risk vs Returns analysis
Table 2: HFIB (Daily and Weekly) vs Benchmark Statistics
Both of the HFIB indices substantially dominate peers in returns as well as risk-adjusted terms with the daily rebal VAMI ending far ahead of the pack & close to 4x the initial investment while the weekly rebal HFIB index finishes at just over 3x despite tcost but with the benefit of interest earned on short proceeds. Other peers all end up below 1.5x terminal value partly due to the high sales loads and fees. E.g., online profiles of the AQR fund show a TER (total expense ratio) ~5.25%. The key observation based on the return differential would be that the incremental tcost of +28bps for daily rebalancing (vs weekly) still leaves us with an extra +533 bps/ ann largely due to the outperformance during the choppier markets of 2019-20. HFIB annualized 5.5Y returns are in the +22.7 to 28% range which is a significant (~5x) multiple of peers which are clustered in the +5 to 7% range.
Given that the HFIB vol (around 13.5 to 14%) is also much higher than the 5.5 (JMNAX) to 6.7% (VMNFX) range, the litmus test will be the realized Sharpe & Sortino ratios which do turn out to be as much as 2.85x higher. QMNNX has a much higher vol than similar peers at 9.8% (but lower than HFIB) which is reflective of an extended and disastrous drawdown (of which only the last ~30% DD is visible in this 5.5Y period) suffered by the AQR fund due to its premature bet on value which remained out of favor till 2021. Indeed, most peer funds had ill timed & outsized bets on well known naive factors while QMIT ensembles bet on more exotic risk premia. The QMIT strategies also exhibit volatility around the March 2020 Covid episode but ended up with an extraordinary positive outlier return of +14% to +15% in March 2020 after the Fed (& plunge protection team) stepped in on 03/23/20 and once the peer de-levering had stopped with statistical arbitrage funds like Jeffries completing their liquidation just in time for a historic ~+110% rally in QMIT’s mean reversion ESB which powered the dramatic resurgence of HFIB. While HFIB had a drawdown episode after the US elections on Pfizer Monday (11/09/20) as a result of the historic 1-day momentum crash precipitated by Pfizer’s announcement of the Covid vaccine, it actually had a sizable run up around the Covid crash delivering on the EMN value proposition. However, the most dramatic peer outperformance for HFIB came during 2019-20 (when quant was left for dead amidst the Value doldrums) and in 2021 due to the double alpha resulting from the Cathy Wood/ Crypto crash amidst an otherwise raging bull market which resulted in triple digit alphas for QMIT’s raw signal spreads.
For a closer look at the HFIB drawdown profile, please see the table below. The key observation is that the MaxDD for HFIB did not occur around the Covid episode. Rather, it was a slow drip as the mean reversion played out post-covid & was later exacerbated by the momentum crash in Nov-Dec 2020 which resulted from the arrival of the vaccine & the resolution of election uncertainty.
| HFiB daily | HFiB weekly |
CumRet | 289.59 | 208.45 |
N Yrs | 5.49 | 5.49 |
AnnRet | 28.11 | 22.77 |
STD | 14.03 | 13.52 |
SR | 2.00 | 1.68 |
Sortino | 3.20 | 2.65 |
MDD | 16.61 | 22.33 |
MDD Start | 2020-06-30 | 2020-04-09 |
MDD End | 2021-01-27 | 2021-01-19 |
MDD Status | Yes | Yes |
# Days Till Recovery | 72 | 107 |
Recovery Date | 2021-04-09 | 2021-05-06 |
Table 3: HFIB Drawdowns
Figure 4: CumRet for the period of drawdowns
Figure 5: CumRet with recovery
At the end of the day, investors eat returns not Sharpe or Sortino ratios, but the risk adjusted metrics are critical to any institutional evaluation of such funds. Based on the risk adjusted metrics, AQR & Vanguard bring up the rear with similarly low Sharpe’s around 0.75 vs 2 for HFIB daily rebal. Analogously, HFIB’s 3.2 Sortino is over 3x that of AQR & Vanguard and 2x that of JP Morgan’s at 1.6. The much higher Sortino vs Sharpe shows that much of the higher HFIB vol is actually upside vol. Hence, the risk/ return tradeoffs highlight the value proposition of QMIT’s HFIB portfolios relative to peers. Furthermore, the HFIB returns over 5.5Y are substantially higher than even SPX despite beta neutrality.
Table 4: HFIB (Daily rebal) monthly returns
In closing, we point out that the only free lunch in finance is diversification. Indeed, a 50/50 combination of our “Sizzling LBOs” which is rebalanced weekly, with the daily rebalanced HFIB EMN strategy could be the “killer app” as evidenced by the ~4 Sortino.
Table 5: HFIB (Daily rebal) and SIzzling LBO (Weekly rebal) performance
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