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Goldman Sees Quants With $200 Billion Nearly Maxed Out on Stocks

Goldman Sees Quants With $200 Billion Nearly Maxed Out on Stocks

A $200 billion breed of systematic investor that helped fuel last year’s market mayhem is now a whisker away from “maximum allocation” to stocks in the latest sign of Wall Street euphoria.

According to Goldman Sachs Group Inc., volatility-targeting quants who buy and sell subject to how much equity prices swing around are all but fully invested in the record-breaking rally.

Now, any spike in volatility could spur these largely rules-based traders to hit the sell button and in turn intensify any market correction.

“We see these funds as more of a market risk than a source of stability in the near term,” Goldman strategists including Rocky Fishman wrote in a note this week.

Goldman Sees Quants With $200 Billion Nearly Maxed Out on Stocks

During the pandemic-lashed first quarter of last year, volatility-control funds added fuel to the rout by offloading some $70 billion of equity securities, before nearly doubling their exposures by the third quarter.

Now, the Goldman strategists “expect to see even higher allocations to equity in year-end filings, leaving very little re-allocation to support markets in early 2021.”

The bullish positioning comes as signs of excess spring up everywhere, including plummeting short interest in equities, extended positioning in options and the fever for penny stocks.

The allocation decisions of these funds are tied to volatility levels rather than market fundamentals. While the Cboe Volatility Index remains some 4 points above its long-term average, actual market swings in the S&P 500 Index have fallen to pre-Covid levels.

The fact that these vol-targeting strategies have gone all-in on the rally to defy the still-elevated VIX “implies that they have high volatility targets,” according to the strategists.

Bad Reputation

Together with the likes of risk-parity funds and leveraged exchange-traded products, volatility-sensitive players have been blamed for intensifying both sell-offs and rallies thanks to the size and cyclical nature of their algorithmic programs. This bad-boy label finds some support in Goldman’s analysis.

These players create a “self-reinforcing loop in volatility that has the potential to alter the path of equity markets,” the strategists find.

Anyone contemplating the historic rally through the pandemic might pay heed to Goldman’s warning on the outsize influence of this breed of quant.

“The potential for them to de-allocate should volatility rise again has the potential to exacerbate any near-term sell-off,” the Goldman team wrote.

©2021 Bloomberg L.P.