Trading the conditionally-correlated
Mortgages, bank stocks,home builders and corporate credit to a lesser extent benefited from the latest round of QE(3) by the FED.
This action was anticipated and therefore the differentiated impact among equity sectors was a potetnial arbitrage for any L/S relvalue equity PM. It is NOT a traditional approach which poses two problems.
- Less experience with such trades can increase loss from entry/exit and trade management standpoint.
- Less data exists to model the trades.
These are meaningful hurdles to clear – especially given low liquidity can increase the cost of being wrong. We suggest that investment managers who get curious about the factors that are derailing the segment, sector and company fundamental approach will discover a tool to differentiate their returns.
Conditional correlation is a variation that favors or weights certain time sequences vs. others.