A risk-on rotation took shape in March with the S&P reaching a new high and small cap rebounding after the dovish Fed meeting. Policy uncertainty remains the biggest contributor to risk-on factor vol, while fundamental factors, especially Realized Value, continue to catch up to the improvement in economic growth, backup in yields, and steepening of the curve.
Our Index level LGBM L-S portfolio gained 1.9% over the past month and the sector focused portfolios had a 73% return hit rate. Industry group, factor, and stock risk all contributed positively to the LGBM portfolio return in March. The biggest vol even was the FOMC meeting, which marked a noticeable shift from risk-off leadership to risk-on. The upcoming payroll and inflation data (April 5th and 10th) will likely bring some volatility to the LGBM portfolio as well.
The LGBM portfolio gained last month despite having a net risk-off factor tilt. That bias toward risk-off factors remains in place this month as well. The next largest exposures within the portfolio are value and GARP. The overall stance of the portfolio is GARP with a risk-off bias. We do not think that is an optimal allocation for CY’24, but it has proven effective YTD. This reinforces the idea that fundamentals should remain the focal point for investors. Returns to risk exposures have been modest and volatile YTD (HERE).
Over the long term, since the inception of the LBGM portfolio testing, the portfolio has been positively exposed to risk-off factors in most periods with the noticeable exception of the post-COVID selloff to 2022. Looking at factor sensitivities within the index LGBM portfolio pre and post-COVID, returns were less tied to risk factors and more tied to fundamental factors (Momentum and Value). Long term, the system works by identifying attractive fundamental factors, but risk factor exposure will be a swing factor in returns as long as policy uncertainty remains high.
The latest April portfolio factor exposure is roughly aligned with March portfolio. There was a marginal decline in risk-off exposure and an increase in Price Failure exposure. Both those shifts are consistent with a broadening out of the catch up trades that have been accelerating over the past few weeks. We list the top 50 names ranking by index model in the report, a full list is available by asking us.
Risk Factors Adding Vol to the LGBM Portfolio While Fundamentals Drove Another Month of Gains: The dovish FOMC meeting mid-March supported risk assets and a broad risk-on reversal. The S&P reached a new high following the meeting and small caps rebounded from their early March weakness. Internally, risk-on factors rebounded at the expense of risk-off factors but Realized Value was the best-performing factor post the FOMC meeting AND over the past month.
Our Index level LGBM L-S portfolio gained 1.9% over the past month, with 8 of 11 LGBM sector portfolios posting positive gains as well. Return contributions by industry group, factor exposures, and idiosyncratic risk were all positive, with the factor contribution being slightly higher than the other two. However, factor contribution was volatile week to week and was the largest drag after the FOMC meeting.
As we discussed last month (HERE), the index LGBM portfolio has the highest exposure to risk-off/Low Volatility and is negatively exposed to risk-on/Earnings Turbulence. That has tied portfolio volatility to shifting investor expectations about Fed policy. Risk-off factors remain the second largest contributor to returns this year, but they are also the second largest contributor to volatility behind Price Mo over the past month. The upcoming payroll and inflation data (April 5th and 10th) will likely bring more volatility to the LGBM portfolio.
Looking at the portfolio net exposures over time, the portfolio has had positive exposure to risk-off factors in most periods apart from the post-COVID selloff to early 2022. The recent risk-off exposure remains at the high end of the normal range for the model. That exposure started to decline with the April rebalance, but the smoothed exposure remains high.
We run factor daily returns within the index LGBM portfolio looking at the pre-COVID (2016-2019) and post-COVID periods (since 2021). Long-term return beta suggests that though exposure to risk-factors were high and contributions were volatile, the long-term return for the basket is tied to fundamental factors including Momentum and Value. Betas to those factors were consistent in both the pre and post COVID periods. We continue to expect the portfolio to gain over the long term, but risk factors will continue to add volatility near term.
Factor exposure for the latest April basket is roughly aligned with March exposure with marginally less risk-off exposure. In addition, Price Failure exposure increased the most and turned positive in April. That shift is consistent with the broadening out of catch up trades.
Below we list the S&P 1500 names currently ranking at the top 50 of the index model. A full index ranking and sector specific rankings are also available by asking us.
