Fund managers are finding it increasingly difficult to deliver profit from investments that outperform market baselines. There is an increase in noise and volatility and the old rules of investing don’t apply in the same way as they used to. New factors, such as momentum trading, are having a dramatic impact on pricing trends; investment managers need better analytics tools to give them a fighting chance of delivering alpha.
To understand the new challenges fund managers face, just take a look at the market trends for 2020. Open-end funds saw the worst performance in memory, losing $317 billion in outflows while exchange-traded funds (ETFs) earned $313 billion. Money market funds saw windfalls early in 2020 but then saw $223 billion in outflows in the third quarter. Using conventional technical tools to create momentum models no longer works because too often the data is too late and too volatile.
Active managers need new tools and new models to help them make better-informed investment decisions. The best way to profit from performance dispersion and get higher investment returns is by using advanced analytics that show pricing trends, not just tracking earnings, revenues, and PE ratios. Tracking trend pricing is the best tool available to active managers who want to beat market benchmarks.
How Market Dynamics Have Changed Investing
In 2020 COVID-19 had an impact on all aspects of our lives, including investing, defining a “new normal.” Assumptions and conventional wisdom about investments have changed with new market trends being driven by the pandemic. In 2020 we saw one of the fastest bear markets on record, we also saw a record $120 billion in stock being traded in U.S. exchanges, and an increase of 50% in trading volume over 2019 with an average of 12.9 million shares trading daily. This rising tide of trading volume makes trend pricing a more important indicator of portfolio performance.
Day traders are largely responsible for this flood in trading volume. Retail investors quarantined at home have been opening accounts on E*Trade Financial, Ameritrade, Charles Schwab Corp., TD Ameritrade Holding Corp., Robinhood Markets, Inc., and online brokerages that offer free trading. A record 8 million new trading accounts were opened in the first nine months of 2020 and retail trading now makes up one-fifth of U.S. stock volume. The day traders are driving pricing trends.
Day traders also are chasing hot markets and hot companies making it impossible to price stocks for high-profile IPOs like Airbnb and Tesla. The Reddit group Wall Street Bets have humbled hedge funds and shown the power of the casual trader to drive stocks like Gamestop into the stratosphere. Retail traders have more influence on price trends than any other group except market makers and high-frequency traders and are driving momentum trading like never seen before. Once a stock becomes popular and gains a following, trading heats up and valuation rises to exaggerated levels purely because of trading momentum rather than investment fundamentals.
In this type of trading climate, active managers have to rethink how they look at market investments. Rather than using traditional performance indicators, they need to follow price trends to take advantage of available profits.
Capture Price Trends to Outperform the Benchmark
To beat the market benchmarks, mutual fund and asset managers need to get the trend allocation right. The underlying fundaments still matter for long-term investments, but the best profit opportunities come from pricing trends.
Watching performance dispersion is one of the easiest ways to monitor price developments since big money flowing in and out of stocks reveals pricing trends. Being able to quickly confirm pricing trends makes it easier to take advantage of uptrends and downtrends to maximize profits. Unfortunately, analyst opinions and company fundamentals don’t always map to stock price and tend to lag behind actual trends. A new type of analytics tools is required.
Trend Capture Rating (TCR) is a new analytics approach from Trendrating that measures portfolio exposure for stocks in an uptrend versus a downtrend. TCR identifies A and B rated securities that are on the rise while C and D rated security prices that are falling. Using TCR you can assess the quality of a portfolio’s trend allocation using actual market data to reveal exposure and improve returns. Comparing the TCR of a specific portfolio to the TCR of the market benchmark quickly provides predictive intelligence about the probability of the portfolio outperforming the index.
When you review TCR analytics you will find that most underperforming portfolios have an inferior trend allocation. For example, the portfolio TCR may reflect a B- while the benchmark TCR shows a B+. To understand the disparity, you need to dig deeper. If there are too many C or D rated stocks in the portfolio you may have to adjust the investment ratios to raise the portfolio rating to B+ or higher to improve returns. Using TCR analytics is a proven strategy to improve portfolio performance by balancing good fundamentals and price momentum.
Rating trends reduce the risk of portfolios underperforming, complements other fundamental metrics, and can be used to uncover new investment ideas. The advantage of the Trendrating TCR Model is it can qualify price trends across a broad spectrum of stocks and market cycles with reasonable accuracy. It’s the ideal tool for investment managers and active traders who need better intelligence to deliver consistent, superior results that outperform the benchmark. Trendrating recently announced that Bloomberg Terminal users can access Trendrating’s “Portfolio Sentinel”(PLUS) application via the Bloomberg App Portal at APPS<GO>.