Fidelity survey - Digital asset interest increasing - What are you going to do with digital assets in 2021?

 

Fidelity Digital Assets generated the Institutional Investor Digital Asset Survey earlier this year that will have implications for investment research and asset allocations next year. More than 25% of US investors now have allocations to digital assets. Over 50% of US investors have direct investments in digital assets and one in five investors have  digital asset exposure via futures. The survey was quite extensive with close to 800 investors participating and was conducted by Greenwich Associates.

There is no question that central banks are taking a close look at digital assets and they will play an important role as a medium of exchange. Investors will have to watch these developments and have a view on how to play it for their portfolios.  

It has helped that digital assets have shown strong performance in 2020, but there are a number of reasons for the strong investor interest this year. There is a growing interest in digital assets as an alternative currency and as a substitute for holding gold. What to do with digital assets is another key question for 2021. 

An equal-weighted index as an alternative to Tesla's addition to the S&P 500

Tesla is joining the S&P 500. This is not new information, but the question is what investors should do about it. There is the primary effect of adding a new stock that will be the sixth largest to the index and will represent 1% of the index. If you use the benchmark, you will have to have Tesla. All passive investors are now betting on Tesla.

The folks at Irrelevant Investor produced a chart that shows the six largest stocks in the SPX index will equal the capitalization of the smallest 369 stocks in the index. The majority of the index seems of little consequence. 

There are ways to take advantage or protect against this high concentration in just a few stocks which have been momentum leaders. The simplest is to reweigh the S&P 500 index through buying an equal-weighted basket or a non-cap-weighted index. This equal-weighted index has outperformed the cap-weighted index significantly over the last three months. This plays on the themes of a broad recovery given vaccines, the renewed focus on smaller cap names and value. 

This is not the only way to play the concentrated index problem, but it is a simple cheap alternative. Another approach is use overlays of focused protection through a collar on the top six names in the index. Investor should not feel hostage to a cap-weighted index. 

FX volatility trend - Convergent monetary policy leads to smooth exchange rates

A recurring hedge fund theme is that global macro investing is dead or at least much harder in the last decade. Who could be surprised with this assessment given there is no volatility in many major markets? For example, look at currency markets. They have been on a decline since the early 1980's. The volatility fall has only accelerated since the Great Financial Crisis. This fall has been on both an absolute and relative basis versus other asset classes such as commodities and equities. For a full report on currency volatility trends see the Brookings Institute draft paper, "Will the Secular Decline in Exchange Rate and Inflation Volatility Survive COVID-19?"

So, what is the cause of this long decline in currency volatility? Inflation across most countries has declined significantly with the standard deviation and median annual inflation well below the average for the post-WWII period and is even low for the post-GFC period. This decline is well below the period known as the Great Moderation. Nominal and real yields are also low and show limited dispersion by historical standards. 

There is every reason to believe that this low volatility currency environment will continue. Rates across advanced economies are all expected to stay low. The Fed has used its power to provide currency swaps to stabilize the dollar. Fiscal policy is being used to stabilize economic growth around the world. Currencies, as a relative price, are stabilized given the underlying economic drivers are stable. 

The question for 2021 is whether a stable global environment will continue or whether economic dispersion will return in growth, inflation, and rates. The consensus is on continued calm; however, when volatility is so low, the cost of betting on increased volatility is cheap. Minsky moments can occur in the global macro arena.    

The big November, alternative reality, and forward expectations

Simple question, if you were given the following information at the beginning of November what would have been your expectations for monthly returns? 

• Change in US leadership; however not a mandate and issues of election confirmations.
• COVID cases rising in US and rest of the world - a big new wave. 
• COVID vaccines developed from three different companies, but unclear when they would be distributed.
• No new fiscal package and the same monetary policy.

This is a game that should always be played by forecasters. Assume you are given perfect foresight of the news, then determine the price action. The expected results do not often match reality. In this case, uncertainty has been put aside and strong equity rotation suggests that investors are expecting a good post-vaccine world.

The SPX gained 10.95 percent, but there were more interesting equity dynamics for November. The equal-weighted SPX gained 14.30 percent and the S&P small cap 600 increased 18.17 percent. Value outperformed growth by over 300 bps with a monthly return of 12.88 percent. 

The strong benchmark gains have masked the significant rotation to value and size over growth and momentum. Of course, this is all relative because the supposed out of favor long-only factors still generated positive monthly returns. However, looking at long/short factors show significant declines for momentum, quality, and volatility factor portfolios. The worst names (shorts) saw significant rallies.

Another rotational shift will come from the increased dispersion in equities. More dispersion means there are more opportunities for stock pickers, active managers. An overweight to the high cap tech names may be ending with the signs of a new normality. Value and size needed a catalyst and that may be present through a shot in the arm.