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High-Beta Stock Trade That Saved 2019 Serves Notice of Its Risks

Sarah Ponczek
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High-Beta Stock Trade That Saved 2019 Serves Notice of Its Risks

(Bloomberg) -- High-beta stocks, occupants of the market’s frenetic edge, were the names everyone wanted to own in the fourth quarter, when they rallied on signs of peace. It’s a taste that may not survive the geopolitical dramas of Friday.

Saviors of active funds, the high-beta group -- defined as companies that do a little better or a little worse than standard benchmarks -- annihilated all comers over the last three months of 2019 as President Donald Trump quieted his trade war. But as new and hard-to-define risks arise in the form of flaring tensions with Iran, the cohort’s shine is in jeopardy after it fell twice as much as the S&P 500.

Obsessing over investment styles may seem pedantic but mattered in the fourth quarter, when an epic rally in the most volatile stocks turned 2019 from a devastatingly bad year for stock pickers into a slightly less-awful one. Choosing correctly among a palate of quant flavors that also includes value and momentum shares is likely to get harder should geopolitical flareups keep calling the market’s tune.

“Those searching for high returns through these leveraged, high-beta type investments -- events like this show you that it can work both ways,” said Chris Gaffney, president of world markets at TIAA. “Volatility is not a one-way street. You may see a shift back out of those and toward more of the vanilla-type trades.”

It’s hard to exaggerate the dominance of volatile equities at year end. Higher in nine of the last 11 weeks, an Invesco high-beta exchange-traded fund stuffed with semiconductor and oil companies surged 20% in less than three months. Its low-volatility counterpart, dominated by REITs and insurance firms, managed just 2%, marking the largest performance gap between the two strategies since the period that followed the 2016 presidential election. The group rose Friday.

For a few active managers who jumped ship from the safety trade that prevailed in the first three quarters, the flip-flop provided a measure of salvation. At the start of October, just 29% of large-cap actively managed core mutual funds were ahead of their benchmarks for the year, Jefferies data showed. Helped by the high-beta rally, 36% beat in the fourth quarter.

Investors everywhere went long the trade at year end, raising their allocation to equities in general and opting for more volatile industries like industrials and semiconductors. In the three months ended in December, ETFs tracking technology stocks took in $5 billion, more than all 10 other S&P 500 sectors combined, Bloomberg data show. Meanwhile, safe industries including utilities and consumer staples had their first outflows of the year.

An ETF that tracks the 50 U.S. stocks most widely held by hedge funds, the Goldman Sachs Hedge Industry VIP fund, saw its holdings in technology and consumer discretionary shares expand in the fourth quarter. At almost 33%, the fund’s tech weighting is the second highest it’s been since it launched in 2016, a Bloomberg portfolio analysis shows.

Alas, in a year when the S&P 500 surged almost 30%, almost anyone trying to beat it was doomed to be thwarted. Even with the fourth-quarter improvement, just 32% of active managers beat their benchmarks over all of 2019, the worst rate in three years.

The question for professional speculators now is whether those who embraced the trade will end up regretting it in 2020. On Friday, traders woke up to news that a U.S. airstrike had killed a top Iranian commander, sending oil prices, bonds, and gold higher while S&P 500 futures fell as much as 1.6%. Adding to pressure was the weakest ISM Manufacturing print since 2009.

And while stocks pared losses throughout the day, bringing the S&P 500 to its 12th week of gains in the last 13, a penchant for defense was back in vogue. A market-neutral Dow Jones anti-beta index that shorts volatile stocks and goes long more steady ones rose, turning its weekly return positive after five straight weeks of declines, the longest since 2015. If it had notched a sixth week of losses, an occurrence that looked probable before Friday, the bout would have been the worst in over a decade.

“The momentum we’ve been working with over the last four weeks has been incredibly strong,” Michael Purves, chief executive officer at Tallbacken Capital Advisors LLC, said by phone. “This may just be that straw that breaks that camel’s back on the momentum trade. There was going to be an excuse to sell anyway at some point.”

--With assistance from Vildana Hajric.

To contact the reporter on this story: Sarah Ponczek in New York at sponczek2@bloomberg.net

To contact the editors responsible for this story: Jeremy Herron at jherron8@bloomberg.net, Chris Nagi

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