The stock market has changed, and investors are going to have to
sharpen their wits.
That’s according to Dmitry Balyasny, the managing partner at the
billion-dollar hedge fund Balyasny Asset Management. The firm
managed $12.6 billion in hedge-fund assets at the start of the
year, according to the Hedge Fund Intelligence Billion Dollar
Balyasny wrote in a letter to investors that the rise of passive
investing and quant funds and a surge in hedge-fund assets had
made the stock market more efficient, leaving fewer easy
It’s certainly been true that as exchange-traded funds have
increased their share of the stock market, they’ve been
blamed for suppressing fluctuations and pushing a measure of
volatility to near-record lows.
And while it’s difficult to attribute the low-volatility
environment to just one driver, ETFs, which allow for the easy
purchase of huge swaths of stocks, may have made the market more
monolithic and sapped it of price swings.
“We think the challenges, consolidation, and changes in the
industry are due to one main factor: There isn’t enough alpha to
make everyone happy,” Balyasny said in the letter, which was
reviewed by Business Insider. Balyasny declined to comment.
He identified three key questions for equity long/short funds, or
those that bet on and against stocks.
Can long/short strategies work in an ETF and index-flow-led
ETFs, which simply track an index, have hoovered up assets at a
high rate over the past decade. US-listed ETFs saw $283 billion
in net inflows during 2016, taking aggregate assets under
management to $2.5 trillion, according to Citigroup.
Balyasny notes that passive investors now own more than one-third
of the US stock market and fundamental stock investors make up
only a small fraction of total trading each day.
This has a few implications, according to Balyasny — in
particular, an increase in the relative importance of stock-price
catalysts, such as earnings releases. From the letter:
“Day-to-day action is very ETF-driven. While this action won’t
change the ultimate valuation of individual companies, it will
increase short-term correlations. Portfolio construction needs to
be tight and tilts need to be very well managed to navigate these
powerful flows. This makes catalysts, earnings, and other events
extremely important to play — and play correctly — because that
is when dispersion is most likely to occur.”
Balyasny cites Japan as an example of what happens to markets
with high levels of passive ownership. More than 70% of Japanese
stocks are passively owned, according to the letter, given the
Bank of Japan’s stock-buying program, “yet liquidity in Japan is
fine, and the fundamental stock selection opportunities remain
robust,” he said.
In other words, passive investing doesn’t kill stock-picking. It
just puts an emphasis on calling the big catalysts for stock
Can long/short investing work in a crowded field?
Another common complaint among investors: Everyone is
chasing the same trades.
“While crowding has been reduced from last year’s peak, most
verticals are still pretty crowded,” Balyasny said. “A correct,
fundamentally variant view is hard to come by, and the alpha is
short-lived as others catch on.”
Still, it’s possible to find unique ideas and deliver alpha,
according to the letter.
“The market is just very competitive,” he said. “While the
business is tough in the short run, it is ultimately good for
Can long/short work in markets dominated by computers?
Quant funds have become popular with investors and are hoovering
up assets. According to a recent Credit Suisse survey, about 60%
of global institutional investors said they were likely to
increase allocations to incorporate some quantitative analysis
over the next three to five years, with pensions showing the most
According to Balyasny, it isn’t a case of fundamental investing
versus quant investing; the two need to combine. From the letter:
“Some of our worst trades are caused by an over-reliance on data
without a variant fundamental view (e.g., a short position in a
fundamentally challenged business with deteriorating current data
where results come in close enough in light of low expectations
to cause a big squeeze).
“On the flip side, some of our best trades have been when our
teams identify some fundamental inflection in a business that has
not been picked up yet in the data. Each approach can be
successful on its own if practiced by a top team, but combining
the two will lead to the best results.”
The letter said Balyasny’s Atlas Global fund was basically flat
for the year to date, while the Atlas Enhanced fund was up 0.78%.
“We believe that as we continue to scale up deployment and enter
summer earnings season, returns should improve back to our target
range,” Balyasny said.