Where’s the Alpha? Characteristics of Alpha-Driven Stocks in 2020
Happy New Year from the Omega Point family! While 2020 was a challenging year for many, we hope that the holidays provided a much needed reset to start 2021 off fresh.
Sometimes the best way to start a new year is to reflect on behaviors and trends from the prior year. With this in mind, we are kicking off our inaugural article for this year by reviewing the qualities associated stocks whose risk in 2020 was “alpha-driven“. We expect that this insight will not only help investors learn from the past year, but also will provide some direction for where research should be prioritized going forward.
What is an Alpha-Driven Stock?
This analysis will be an update to a similar analysis that we conducted going into 2020, and as such, we’ll be using the same interpretation that we’ve used in the past. In particular, our definition centers around the drivers of the expected volatility of a security. Stocks that are “alpha-driven” move because of idiosyncratic drivers that are largely specific to the company. Conversely, stocks that are “factor-driven” move due to external forces that are systematic in nature, such as economic reports, geopolitical events, or sector impacts.
For the purposes of our analysis below we define an alpha-driven security as one where 67% or more of its expected risk, as defined by the Axioma US 4 Medium Horizon risk model is idiosyncratic. We’ve also expanded our analysis to include factor-driven securities (67% or more of expected risk is systematic) and neutral securities (neither factor-driven or alpha-driven).
Alpha Deteriorates During Crisis Periods
We used the above framework to segment the Russell 3000 into the three groups (alpha-driven, factor-driven, and neutral) on a month-end basis from Dec 2019 to Dec 2020.
As a reminder, the last time we ran this analysis for 2018 and 2019, we found that the percentage of alpha-driven names in the Russell 3000 had been on the decline, with a particularly large drop during the Q4 2018 market dip. By the end of 2019, the alpha-driven group had started to eke back, ending the year close to 50%.
The chart below shows that in the beginning of 2020, we saw this trend continue, with the percentage of alpha-driven names hitting just over 50% in Jan 2020.
However, this trend started to reverse course even before the pandemic started, with a roughly 10% decline in the percentage of alpha-driven names from the end of Jan 2020 to the end of Feb 2020. During this time, there were still 1000-1500 stocks that fell into the alpha-driven category. However, after the pandemic hit the US in March 2020, the alpha-driven stock group compressed significantly to make up less than 15% of the Russell 3000 and stayed in that range until mid Q3 2020. This percentage was over 2x lower than at any point during all of 2018 and 2019! Despite this setback, the portion of alpha-driven stocks in the universe has been steadily increasing since then. Though the total number of stocks in this group is still below 1000 names, we are trending in the right direction for improved opportunities for stock pickers in 2021.
Referencing the same chart, we see that the neutral group was very consistent, maintaining close to or above 50% of the universe for the entirety of 2020. Interestingly, we can see that the factor-driven group, which was in the single digits at the beginning of the 2020, increased its proportion of the Russell 3000 by over 3x from Feb 2020 to Mar 2020. This makes intuitive sense, as crisis periods are typically more heavily influenced by systematic market movements. Conversely to the trend we saw with the alpha-driven group, the factor-driven group started to shrink in mid Q3 2020 and has been on the decline. This again supports the inference that the hunt for alpha may become easier for fundamental stock pickers going into 2021.
DNA of Alpha-Driven Stocks
Though securities can become more or less alpha-driven (and at the same time, less or more factor-driven), they still have exposure to systematic factors. These exposures can provide some wisdom on the qualities of alpha-driven stocks in 2020. Again, we used the Axioma US 4 Medium-Horizon risk model and calculated the median exposure for each of the style factors across our Russell 3000 groups, as well as the total Russell 3000 universe.
Size Factor Exposure
Unsurprisingly, the alpha-driven names consistently have a much lower Size factor exposure compared to the overall Russell 3000 universe as well as the factor-driven group. This indicates that alpha opportunities tended to be more prevalent lower in the market cap range and were tougher in the mid and large cap space.
Growth vs. Value Factor Exposures
The Russell 3000 universe decreased in median Growth factor exposure over 2020, with the neutral group following a similar trend. The factor-driven group followed a similar overall trend, but did have a sizeable increase at the beginning of the year going into the March downturn before starting the downward fall through the end of the year. The alpha-driven group, on the other hand, looked completely different compared to the other groups, with an extremely sharp decline from Feb to March 2020 and a steady but meaningful ascent in the latter half of the year.
While the alpha-driven group did see some downward movement on the median Value factor exposure, the factor-driven group stole the show with an extreme upward trend in median Value factor exposure over the course of 2020.
We’re now going into 2021 with the median alpha-driven stock having much higher Growth exposure and much lower Value exposure as compared to the overall median Russell 3000 and factor-driven stocks.
Liquidity Factor Exposure
The median Liquidity factor exposure shows perhaps surprising trends for the alpha-driven securities. Traditionally, we might associate heavy alpha opportunities with less well-known and more illiquid names. However, we see the opposite trend here (and have since before 2018), where the alpha-driven group has a substantially higher median Liquidity factor exposure throughout all of 2020. The alpha-driven group did take a dip in the Liquidity factor exposure at the same time that the factor-driven group had an increase during and after the March 2020 downturn, possibly due to investors moving out of riskier, more idiosyncratic sectors that were hard hit by COVID-19 restrictions. Despite this minor convergence, overall, the alpha-driven group maintained a very high Liquidity factor exposure.
Technical (Momentum, Beta, Volatility) Factor Exposures
Many investors experienced heartache in 2020 from the Momentum, Market Sensitivity (aka Beta), and Volatility factors in 2020, with major Momentum reversal, a Volatility rotation, and the runaway Beta phenomena. Unsurprisingly, given the unruly behavior of these factors, there were some interesting trends in the alpha-driven and factor-driven groups.
Starting with the Volatility factor, we saw the median exposure from this factor skyrocket for the alpha-driven group with the beginning of the pandemic. Though the median exposure tapered off through the rest of 2020 for the alpha-driven stocks, it remained much higher than the factor-driven group or the total Russell 3000 universe.
The Market Sensitivity factor showed us an opposite trend as compared to the Volatility factor. The median Market Sensitivity factor exposure for the alpha-driven stocks was much more in line with the neutral group and overall universe at the outset of 2020 as compared to the factor-driven group. However, after that, the median exposure plummeted in March and April 2020 for the alpha-driven group but stayed consistent and then increased for the factor-driven group. This tells us that the runaway beta effect that we saw in 2020 was likely more rampant for factor-driven than alpha-driven names.
Last, but not least, the Momentum factor showed a massive and sharp increase in median exposure for the alpha-driven group, going from -0.83 to +0.07 in only three months from March 2020 to June 2020! This spike happened all while the median Momentum exposure was steadily declining for the factor-driven and neutral groups as well as the Russell 3000 universe overall.
To summarize, we found that while 2020 was a tough year in terms of alpha opportunity, we may be reversing that course. Going into 2021, the median alpha-driven stock has relatively:
- lower market capitalization
- higher growth
- lower value
- higher liquidity
- higher volatility
- lower beta
- higher momentum
Next week, we’ll continue to dissect the exposure profile of alpha-driven stocks using different risk model providers to gain insights from varying lenses.
US & Global Market Summary
US Market: 12/21/20 - 12/31/20
- Despite the calamitous year, the Dow, S&P 500, and Nasdaq closed 2020 with gains of 6.6%, 15.5%, and 43.2%, respectively.
- A favorable U.S. election outcome, large-scale vaccination campaigns, steady improvement in economic data and signs that a fiscal stimulus deal will be eventually reached in Washington helped Wall Street continue its rally through year-end.
- U.S. Labor Department report showed the number of Americans filing first-time claims for unemployment benefits fell for the second straight week, but remain elevated more than nine months into the crisis triggered by the pandemic.
- Investor sentiment was boosted by U.K.-approved AstraZeneca's (AZN) COVID-19 vaccine, but fresh Johns Hopkins University data showed the U.S. is averaging over 2,000 coronavirus deaths and 180,000 cases each day.
- All eyes are on two U.S. Senate races in Georgia next week that will determine control of the chamber and influence Democratic President-elect Joe Biden's ability to enact his agenda..
Normalized Factor Returns: Axioma US Equity Risk Model (AXUS4-MH)
- Momentum was the biggest winner over the 2-week period, and continues to march past it’s extremely oversold designation from early December when it was -2.48 SD below the mean.
- Growth continued to recover from its trough on 11/25, and currently sits comfortably above the mean.
- Earnings Yield is showing renewed positive movement and represents the week’s 3rd biggest gainer.
- Market Sensitivity keeps falling further from it’s earlier Overbought label, now sitting at +0.42 SD below the mean.
- Volatility and Value continue to freefall and round out the two biggest losers over the 2020 holiday period.
- US Total Risk (using the Russell 3000 as proxy) declined by 121bps.
Normalized Factor Returns: Axioma Worldwide Equity Risk Model (AXWW4-MH)
- Momentum and Growth both made very impressive showings to end the year in positive territory.
- Market Sensitivity extended its recent declines as it approaches the mean at year-end.
- Value and Volatility continued to show weakness but remain in positive territory, for now.
- Size was once again the week’s biggest global loser as it falls into negative territory.
- Global Risk (using the ACWI as proxy) decreased by 91bps.