You may have seen the headlines mentioning that several high-profile Technology/Media/Telecom (“TMT”) managers were down big in September. They were. Given that the Nasdaq was slightly positive in September, the strategy losses surprised many investors. But should they have?
In August, we wrote a piece on SaaS that explained much of the dispersion in TMT performance year-to-date and over the last 1.5 years. The same factors that led to outperformance year-to-date led to strong underperformance in September. There was a large reversal in what has been profitable – SaaS and growth/momentum – leading to a dramatic rotation out of those factors. PivotalPath’s proprietary SaaS Basket, for example, was down 9.2% in September after being up 46.5% year-to-date through August 2019.
Based on our risk factor model, with SaaS down 9.2%, we would have expected the TMT peer group to be down roughly 2.4%, with top quartile funds down 1.1% and bottom quartile funds down 4.3%.
In reality, PivotalPath’s TMT Hedge Fund Index was down 3.8%, which is even more than what the model would have predicted. The dispersion among TMT funds widened accordingly: top quartile funds finished the month up 0.4% while bottom quartile funds were down 9.2%, on average.
Is this move out of the ordinary? No. This is just reversion to the mean. In fact, our model would have predicted them to be down based on their positioning over the last 18 months. The most popular software stocks were trading at all-time highs before September, so it is reasonable to expect the spike in volatility. While SaaS exposure accounted for much of the underperformance, exposure to growth/momentum is another explanatory factor, albeit to a lesser extent. This combination exacerbated losses.
Conversations with TMT managers have affirmed these findings. They blame the rotation on profit-taking, which led to multiple contraction during the month. Overall, they were not terribly surprised by the drawdown in software. On the contrary, they believe the reset was healthy and think the long-term fundamentals are still intact.
All of this should give investors confidence that September was nothing out of the norm.