Blog Posts — January 12, 2021

Sentiment-Savvy Risk Takers Cashed In on a Chaotic Year

While taking risks by not wearing a mask offered zero upside in 2020, taking sentiment-savvy risks with your portfolio delivered bigtime. Using the Qontigo Sector ROOF Scores[1], we developed a methodology to construct Risk-On and Risk-Off variants of the STOXX USA 500 index portfolio. In a previous blog post, we compared the performance of our two sentiment-based portfolios in three market phases: the Pre-COVID-19 rally (Q4 2019); the COVID-19 Crash (Q1 2020); and the COVID Rebound (Q2&3 2020). In this update, we look at the full-year performance of our two portfolios versus their parent benchmark. We examine the impact of the pandemic on the ROOF personalities of several key sectors and how these mood swings affected their active allocation in our ROOF portfolios[2].

The chart below shows the cumulative returns for the Risk-On (blue line), Risk-Off (green line) and parent STOXX USA 500 index (black line) for 2020. The two ROOF-based portfolios were rebalanced monthly using the Sector ROOF scores at the end of the previous month to ensure that their compositions reflected then-current investor sentiment.

Source: Qontigo

US equities, as represented by the STOXX USA 500 index, recovered all their Q1 COVID-19 losses by the end of Q3 2020 and then added gains in Q4 on the news of multiple vaccines and continued accommodation by the Fed. By the end of 2020, the STOXX USA 500 index was up 22% for the year, a remarkably strong result considering the global pandemic’s devastating impact on both the global health system and economy. These returns matched the 22% gain the index achieved in 2017, when the average market volatility was a third of what it was in 2020[3]!

During 2020, being consistently bullish and holding the Risk-On variant of the STOXX USA 500 would have delivered a gain of 31%. Conversely, an investor rendered risk averse from all the negative COVID-19 headlines and holding the Risk-Off variant of the STOXX USA 500 index would have recorded a gain of ‘only’ 9%, or less than half that of the parent index and less than a third of its Risk-On counterpart. Clearly, being risk averse in your social life, while being risk tolerant in your US equity portfolio, would have paid-off handsomely.

We also know that the pandemic had a dramatic impact on many sectors. This economic impact translated into big changes in some sectors’ ROOF personalities[4], with some becoming more or less risk tolerant/risk averse in character as the year progressed. This, in turn, affected their allocations in our Risk-On/Risk-Off portfolios.

The charts below show the evolution of the ROOF personality for three sector pairs: Health Care (blue line) and Utilities (green line) on the left; Financials (blue line) and Consumer Discretionary (green line) in the middle; and Information Technology (blue line) and Telecommunication Services (green line) on the right. As a reminder, a positive value on the Y-axis indicates a risk-tolerant personality and a negative value means a risk-averse personality.

Source: Qontigo

The chart on the left shows a change in the ROOF personality of the Utilities sector (green line) during 2020. It began the year with a very strong risk-averse personality and a ROOF score of below -1.5 during all of January and February. The COVID-19 crash in March all but erased this strong personality, bringing its ROOF score to 0.0 by May 1, 2020. During the rest of the year, as the market recovered, it not only regained its risk-averse character, but strengthened it, and ended 2020 with a ROOF score of -2.1.

The middle chart shows a similar effect, though less dramatic, on the Financials (blue line) and Consumer Discretionary (green line) sectors. From the beginning of the year, both saw their personalities weaken during the COVID-19 crash, then recover, and finally end the year with even stronger personalities than they started with.

The chart on the right shows the impact on Information Technology (blue line) and Telecommunication Services (green line). The technology sector started the year with a risk-tolerant personality, became neutral by May 1 because of the COVID-19 crash, then regained its risk-tolerant character, ending the year more risk tolerant than it began. Telecommunication Services (green line) ended the year as it started, with a neutral ROOF personality, being neither risk tolerant or risk averse. After the COVID-19 crash, however, it became risk averse and maintained that character from April through to September.

Changes in the ROOF personalities of these key sectors affected both the sizes and sometimes the signs of their active allocations in both the Risk-On and Risk-Off portfolios throughout the year. The table below shows the average monthly active weights of each sector in the Risk-On portfolio during 2020.

Source: Qontigo
  • Consumer Discretionary (CD) started the year as the biggest active allocation in the Risk-On portfolio at +7.4%. By May, its active weight had declined to just +2.4%, dropping to fifth place in terms of active allocation behind Consumer Staples (CS) at -4.5%, Information Technology (IT) at -3.3%, Health Care (HC) at +3.1%, and Telecommunication Services (TS) at +2.5%. By the end of the year, it regained its place in the Risk-On portfolio with an active weight of +5.7%, behind only Financials (FI) at -5.8%.
  • Financials (FI) saw its -6.1% January active weight decline to just -2.1% in May and its position in the active allocation rankings drop from second place to seventh in that time. During the second half of the year, Financials rebounded to the top spot by the end of December at -5.8%, just ahead of Consumer Discretionary (CD).

The damage to the economy from the pandemic was evident in the change in allocation to Industrials (IN) in the Risk-On portfolio. Industrials started the year at +4.6%, ranked third in terms of active bet, and finished the year a just 0.5%, tied for last with Materials (MA) and Real Estate (RE).

  • Information Technology (IT), the other big story of 2020, started the year with an active weight of +2.8% in accordance with its modestly risk-tolerant ROOF scores (barely positive). Its active allocation then switched signs, reaching the number-one rank in terms of active bet at -5.8% in August, as its personality became risk averse due to the pandemic[5]. As investors began to bet on an economic recovery driven by news of multiple vaccines, its allocation changed sign again during the big sector rotation trade and ended the year at +3.2%, slightly higher than where it started.
  • Telecommunication Services (TS) was another sector that saw a change of sign in its active allocation during the year, starting at -1.5%, turning to +1.7 by April because of COVID-19, and ending the year at +2.2%.
  • Utilities (UT) started the year at -2.1%, dropped to just -0.3% in May when its ROOF personality changed from risk averse to neutral, and ended the year at -1.5%, as it regained its risk-averse character.

The changes were a little less dramatic in the Risk-Off portfolio, as one would expect, but still significant. The table below shows the average monthly active sector allocation in 2020 for the STOXX USA 500 Risk-Off portfolio.

Source: Qontigo

In this portfolio, most of the jockeying for top active bet position occurred among the top of the rankings. Except for Financials (FI) and Information Technology (IT), most changes in active weights were more moderate than in the Risk-On portfolio.

  • Consumer Discretionary (CD), a strongly risk-tolerant sector, never relinquished its top rank as the most active sector, increasing its under-weight from -7.8% in January to a whopping -10.7% in December. Conversely, Consumer Staples, a consistently strong risk-averse sector, saw its active allocation remain steady, ranging from +6% in January to +5.3% in December.
  • The personality mood swings of Financials (FI) went from +7.4% in active weight at the start of the year to just +2.2% in July, and recovering to +6.9% in December. The impact of the pandemic on the economy was equally evident when looking at the change in active allocation for the Industrial (IN) sector, which started the year at -5.0% and ended it at just -0.6% after a slow and continuous decline.
  • As with its Risk-On counterpart, the Information Technology (IT) sector saw the most dramatic change in active allocation, swinging from a strong under-weight of -5.9% to an over-weight of +2.2% by August, and returning to an under-weight -6.3% by December.
  • Health Care (HC) was the only other sector with a material change in the sign of its active allocation. It started the year at an under-weight of -2.8%, before increasing to a big under-weight of -7.9% by March. As its personality gradually became more neutral (from risk tolerant), its under-weight softened to just -1.2% in September, before turning mildly positive at +1.1% and +1.2% in October and November, respectively, before ending the year as an under-weight at -2.4%.

Another impact of COVID-19 on our ROOF Portfolios can be seen from the turnover statistics of our Risk-On and Risk-Off monthly rebalancing. COVID-19 increased the turnover of our risk-on portfolio by 50% in 2020. The chart below shows the monthly average two-way turnover at each rebalancing for our STOXX USA-500 Risk-On portfolio[6]. The monthly average for the prior seven years was 30.3%. In 2020 it shot up to 46.4%. In March 2020 alone it reached 104.4%! Conversely, 2020 was an average year for the STOXX USA 500 Risk-Off portfolio with a monthly two-way turnover of just 20.3% versus a seven-year average of 20.5%.

Source: Qontigo

We conclude that although being risk tolerant paid off in 2020, it would have only done so for those investors able to keep up with the changing personalities of each sector. As the pandemic impacted us, both on a human and economic level, so did it impact the fundamentals of each sector. In doing so, it created some dramatic changes in investors’ perception of these sectors as risk tolerant or risk averse. These changes led to very different active sector allocations in portfolios designed to capture the upside of a risk-on market or the downside protection of a risk-off one.


[1] The ROOF Scores are Qontigo’s sentiment indicator. More information on Sector ROOF Scores can be found here.

[2] Note that the ROOF Portfolios are not official products of STOXX indices and are being maintained by the Qontigo Applied Research team for market-analysis purposes only.

[3] The average predicted volatility for the STOXX USA 500 index in 2020 was 24.2% versus 7.3% in 2017 using the Axioma US4-MH model. So, technically, 2020 got us about a third of the risk-adjusted bang for the buck than 2017.

[4] Sector ROOF Personalities are described in the Sector ROOF Score methodology paper available here.

[5] That’s the whole ‘safety-in-numbers’ thing. As Big Tech became a dominant part of the market, it became risk averse to be long technology stocks like everyone else, and no longer risk tolerant.

[6] Each box is a month and the size of the box is based on the turnover for that month