Capturing a Kodak Moment: How to Maximize the Alpha in Your Ideas

Of the many services we provide our clients, one of the more common requests we receive is to construct a hedge basket designed to offset the factor risk inherent in a new (or existing) alpha-generating idea.

For example, a long/short PM wants to add a sizable long position in Carnival Cruise Lines (CCL) due to a rebound in global travel activity, but is worried about the additional Volatility and sector exposure that comes with it. In the past, we'd create a custom hedge basket of names on a one-off basis, a process which had its limitations.

Today, we’re excited to introduce our newest feature - Smart Trades - which empowers Omega Point users to create and tailor a hedge for any single-security trade on the fly, allowing you to remove any unwanted factor bets, target sector requirements, and/or maximize the alpha in the trade.

In the following walkthrough, we’ll demonstrate how easy it is to create baskets yourself, using a name that’s seen its fair share of headlines in the past couple of weeks.

Eastman Kodak: A Mixed Picture

Eastman Kodak (KODK) shares have whipsawed violently since the end of July, with investors making and losing millions in the company within the span of a week. This volatile price action was initially sparked by news that the company was being awarded a $765 million Defense Production Act loan from the US government to produce COVID-related pharmaceutical components. As a result, shares popped from $2 to $60 in a couple of days. The problem is that on July 27, a day before the public announcement, 1.6 million shares traded (~8x the stock’s ADV), and questions arose about potential insider-trading activity. In response, shares have given back a significant amount of those initial gains.

‍Eastman Kodak: YTD Return 2020

While we have no desire to weigh in on any sordid or political details here, this stock does make for a juicy alpha story. So let’s imagine I’m an investor who had been paying attention to federal disclosures, and saw that Kodak had restarted its previously shut down lobbying arm on April 1st. Subsequently, let’s say I constructed some sort of long thesis baking in upside to the very depressed stock price (-51.8% YTD on July 1).

Because my bet on Kodak is completely driven by my opinion on the company, I might have wanted to put a hedge on to isolate the alpha in this long idea. Here’s how this would look using the Smart Trades workflow:

Step 1: Create a Research Topic

First, I select the security that I’d like to create a Smart Trade for, as well as the risk model that I’ll be using for the computation. Then I can name my new topic and write a brief description of what I’m trying to accomplish.

Step 2: Create a Smart Trade Experiment & Trade setup

Click on the Smart Trade option to get started and configure the trade parameters, including trade date (we arbitrarily used 7/1 for this example).

Step 3: Select Universe

Next up, we’ll decide on the universe that we want to pull our hedge constituents from. Using our security screener, we can use various filters to create a custom universe. This can include targeting factor exposures, or filtering names out based on sector or market cap. In this example, we used securities in the Russell 2000 with an ADV greater than $10mm.

When I hit “Next”, the Smart Trade will immediately be created, optimized, and then displayed on screen.

Step 4: Iterate on rules and finalize experiment

In this final step, the reference security (KODK), the constructed basket, and the combined L/S smart trade are displayed side-by-side for quick comparison, including seeing the impact of the basket on the specific risk of this trade. If I wanted to, I could further tweak the constraints - changing the size of the basket, concentration rules, and targeting specific factors.

‍The key takeaway here is that by pairing this new basket with my KODK long, I would have taken the specific risk of my KODK idea from 66.8% to 98.7%, essentially allowing for a pure-alpha play. Because the huge lift in KODK shares at month’s-end was entirely driven by alpha, this trade would have allowed me to make more money and avoid any unintended factor influence on my return in the meantime.

Now imagine you had wanted to short KODK after the unprecedented move, and wanted to create a pure alpha short trade. In that case, you could use the same process and come up with a basket that would hedge out all unwanted factor exposure from the KODK short. The flexibility of Smart Trades allows you to have full control over your hedge creation process.

We’re confident that this new basket construction workflow can be valuable to your investment strategy, and encourage you to reach out if you’d like to see a demo or walk through any use cases that you might have.

US & Global Market Summary

US Market: 8/3/20 - 8/7/20

• The market ended flattish on Friday as it digested the latest jobs report and summarily dismissed lawmakers’ inability to secure a new COVID relief bill.
• Friday’s jobs report showed a 1.78 million increase in non-farm payrolls in July, better than the consensus estimate of 1.48 million. The unemployment rate came in at 10.2%, vs. 10.6% expected.
• Still, other data released this week showed a 54% surge in announced job cuts in July, and a private payroll increase of 167,000, far lower than the consensus estimate of 1 million. The labor market remains disjointed and volatile as the nation continues to grapple with the coronavirus.
• After a heavy week of TMT earnings (including DIS and MTCH), tech stocks saw some weakness in the wake of Trump’s executive orders banning Chinese apps TikTok and WeChat from the U.S. unless they're sold to other companies within 45 days.

Normalized Factor Returns: Axioma US Equity Risk Model (AXUS4-MH)

• In a relatively quiet week on the factor front, Market Sensitivity was the biggest winner, up +0.21 standard deviations and now on the cusp of exiting Oversold space.
• Momentum saw continued strength as it climbed closer to Extremely Overbought territory at +1.93 SD above the mean.
• Volatility appears to have bounced off a trough of -2.18 SD below the mean on 8/4, and may shed its Extremely Oversold designation in the next week if the trend continues.
• Size continued to revert down towards the mean after peaking at +1.15 SD above the mean on 7/24, and now sits in Neutral territory.
• US Total Risk (using the Russell 3000 as proxy) declined by 13bps.

Normalized Factor Returns: Axioma Worldwide Equity Risk Model (AXWW4-MH)

• Profitability was once again the top performer globally, now sitting firmly in positive Neutral space.
• Market Sensitivity saw slight gains on a normalized basis as it started to head back towards the mean.
• Interestingly enough, Momentum started the week at +2.5 SD above the mean, peaked at +2.58 SD above the mean on 8/5, and then ended the week back at +2.5 SD above the mean. It remains an Extremely Overbought factor.
• Exchange Rate Sensitivity continued to fall back towards the mean after reaching a peak of +2.62 Sd above the mean on 7/9.
• Value fell a bit further into negative territory, garnering an Oversold designation at -1.08 SD below the mean.
• The decline in Size continued as it crossed into negative space at -0.12 SD below the mean.
• Global Risk (using the ACWI as proxy) declined by 11bps.

Best,
Kris