The market forces really driving the ASX's volatility

By this point, volatility has gone from market buzzword to stark reality for the ASX. 

The unremarkable performance seen on an index level belies dislocations that have left investors of all stripes rubbing their heads. An increasingly fraught and uncertain macro picture have undoubtedly contributed, but there are a number of impacts closer to home that suggest this volatility won't be going anywhere.

One person who is seeing many of these factors playing out in realtime on exchanges and across the ASX is Ten Cap's Jun Bei Liu, and who expects these new market dynamics to be a new normal for investors. 

"Market volatility hasn't gone up that much," she told me. "It's the stock level volatility that will continue to go higher and higher."

Here she gives her view on many of the biggest contributors - like the rise of ETFs and passive flows, the consolidation of super funds and loss of active manager mandates, and the influence of global hedge funds and short sellers - and whether it's creating opportunities for active managers and retail investors. 

Not so super for some

One of the biggest drivers of recent ASX volatility has been the reallocation of large investment mandates - huge amounts of capital that superannuation funds give to active managers in order to invest. 

"In the last 12 months, we have seen a significant amount of mandate movements, mandate losses and also internalisation," said Liu. "We're talking about billions and billions for the last 12 months." 

This has largely been the result of consolidations between mid-sized super funds, such as the recent merger of TelstraSuper and Aware Super, which saw specialist managers lose mandates as part of the merger. Another contributor has been super funds moving more capital away from active managers and into internal management.

One immediate consequence is the forced unwinding of portfolios that are often focused on specific parts of the market, such as small caps. Those positions are sold and then the money reinvested in the benchmark before the super fund makes a decision on where it wants to allocate the money. 

Smaller names like Life360 (ASX: 360), GDG (ASX: GDG) and Waypoint REIT (ASX: WPR) are some stocks that have been caught in that crossfire recently. 

"This is essentially a transition," said Liu. "They're selling everything else and then they're piling the money into the top 20 before they decide what to do. In the last few months it's been really, really prominent."

As a result, relatively sizeable positions in smaller names and the money piled into the biggest names that dominate the benchmark. Given that BHP and CBA each account for around 10% of the total value of the ASX 200, the money flowing from smaller funds to the broad index exacerbate market concentration.

While it's an existential threat to funds management, it does also present short-term opportunities, says Liu. Fund managers can swing trade the short-term fluctuations when a stock is subject to an enforced selloff, but the window is small and the potential upside limited. 

"The reversal can happen very quickly," she said. "Because the share price will be unfairly pressured, you will have buyers come back."

Instead, if it's a stock on her radar, Liu may use it as an opportunity to get in at a better price and eke out extra returns. 

"I think there's easier money to be made," she said. "It's much easier to go to the other side, waiting for it to be sold off and then buying into it. We will take our time and then we'll aim to be the very end of the selling and take advantage of the reversal."

But it's not something that individual investors should necessarily be trying to take advantage of, especially given there's more attractive prospects elsewhere. 

"There's return opportunities everywhere in this market. The market is so volatile, you have so much opportunity."

Going the other way

Another factor is the influence of foreign hedge funds, especially on the shorting side. It's another contributor to the intraday volatility seen across many ASX stocks. 

"These days companies are pretty good at structuring announcements to get the stock to rally. And then short sellers are forced to close their book because they can't manage the risk. They get stopped out very quickly."

"So what we do is that we actually short on the day, not when it rallies. You see the share price falter because the demand is not real. It's all artificially supported by short sellers buying back."

"We see it again and again in this market. In the last 6 months I would say a lot of my return has come from short selling, which is quite rare. In a strong market, short selling is almost like an insurance policy, but in this market, shorts are actually driving a lot of return."

Short covering also accounts for some of the big daily jumps seen on ASX tech names, which had been shorted as part of the SaaS-pocalypse. When ASX tech stocks rallied recently in line with US tech, global hedge funds needed to cover their shorts, causing the stocks to bounce more aggressively. 

Global influence

As the world's largest copper miner, BHP Group (ASX: BHP) in particular is also popular with global fund managers and investment funds looking for solid copper exposure. 

"Last year we saw quite a lot of international money coming into our market and into our banks. You see all the top names like CBA being beat up because Australia was looking pretty good relative to the others and now, in the last six months, you are seeing international money flowing into the likes of BHP. It replaced the CSLs and the CBAs because everyone's worried about the Australian economy, so offshore flow has been purely going to BHP."

"I've seen quite a few analysts downgrading BHP now because of it's valuation, but there's no other way of expressing gaining exposure to copper, world's largest copper company, and on a technical piece, it doesn't look that expensive.

If you want to buy a copper company, it's BHP. International players don't buy into smaller names."

Another development has been how dramatic the market responses now are to company upgrades and downgrades.

 "Australia's become very much an earnings momentum market," said Liu. "It's about earnings trajectory, it's actually not about multiple anymore."

And Liu says that often falls at the feet of active managers, not the passive flows that are driving much of the distortion elsewhere.

"Active managers are not patient," she said. "When something changes, it's 'whoa, just get me out of here'."

"Passive money takes some time to come through. I think it's the active managers in anticipation of what the passive money will do." 

Again, that creates opportunities for those who are agile enough to respond. 

"If you know these things will happen, then you can be very tactical about your positioning into it. It's ridiculous how much they fall."

But she cautions against retail investors trying to do the same. She points to stocks like CSL (ASX: CSL) and Cochlear (ASX: COH), which ostensibly offered multiple good entry points, only to then fall further. 

"If I was a retail investor, without knowing what is happening behind the scenes, it's very hard to step in. You do need to know what is happening fundamentally and then you can make a judgement."

"As a professional investor we see everything... For retail investors there's a lot of landmines, so you have to be very careful."