13 JUN

2019

Absolute Return , Topics

The trade narrative rocks the boat

At the end of April, investors were having trouble reconciling the strong performance among equity markets with soft macroeconomic data. However, just a single text from Tweetanator rocked the boat. Although US 1st quarter earnings growth came in better than had been feared at ‑0.43% YoY on average, the impossibility of a good trade deal being signed soon will make it difficult for corporations to reach their targets during the rest of the year.

Apart for a few exceptions, equity markets were down. Exporting nations like Sweden, China, Korea, Japan and Hong Kong, as well as the main US equity indices, were the hardest hit returning between -6% and -10%. European indices posted slightly less disappointing performances on average, with returns ranging between -3% and -5%. Argentina, Brazil and India were the positive outliers. Despite having to deal with significant domestic political and economic uncertainties, a lower cost of debt in US dollars and a lower cost of energy is providing relief for these economies. in terms of sectors, defensives such as healthcare, utilities and staples outperformed cyclicals.

There were strong trends in sovereign rates. The markets are pricing-in softer economic data, with yields on US 10-year issues easing almost 30 bps to end the month at 2.22%. However, some consider the street to be too bearish since expectations are pricing-in 3 Fed rate cuts this year. The other major sovereign issues followed a similar trend.

Commodities posted mixed performances. Returns this month can be clustered into strong positive performances for soft-commodities and poor performances for oil, gas and industrial metals. Returns ranged from -3.5% for palladium to -16% for WTI.

The HFRX Global Hedge Fund EUR returned -1.13% during the month.

Long short equity

Performances from long short equity funds were mixed. Directional strategies and funds focused on technology and the consumer discretionary sectors were logically penalized more heavily by the market headwinds. However, on average, year-to-date, performances are quite good. One of the prime brokers we track states that the YTD average performance for global and US hedge funds is still in low double digit figures. Their clients have been net sellers in the market for some time and are reducing their gross and net exposure. Growth plays are still in demand and the value vs growth ratio is reaching new lows. Recently, the rhetoric regarding trade tariffs led managers to rotate into defensives and out of cyclicals. The heaviest increases in short positions have been observed in the consumer discretionary and technology sectors, while many short plays among materials and consumer staples have been closed-out.

We still prefer long short equity strategies because the dispersion, between and within sectors, creates strong alpha opportunities for the strategy. Also, this strategy offers a wide range of levers that can be used to benefit from industry restructuring and sector dispersion, from a long or short perspective.

Global Macro

The strategy posted dispersed performances but index returns were slightly negative for the blend macro strategy. The most penalized strategies were systematic managers which usually do not deal with whipsaw movements well. However, there were strong trends in equities and fixed income that opportunistic managers were able to capture more easily. Historically, macro strategies have had greater difficulties generating stable and uncorrelated returns. In this environment, we tend to favour global discretionary macro managers that can use their analytical skills and experience to generate profits from a few strong opportunities worldwide. 

Quant strategies

May was not that bad for quantitative strategies. At the index level, volatility strategies were the only ones which returned a decent positive performance. At the fund level, we saw a number of funds in different quantitative strategies that we track and invest in benefit from the increasing levels of volatility to return healthy performance figures in a risk-off environment. Trend followers returned rather flat performances as any gains on long fixed income positions were offset by positions in equities. Sophisticated multi-strategy quantitative managers that we track have fared well lately, particularly during phases of increasing market stress. 

Fixed Income Arbitrage

The strategy has benefited from a much better opportunity set in the US (the widening of the basis in the US has doubled compared to last year), as well as some opportunities in Europe such as France. It is important to highlight that funding and access to repos is one of the pillars of the strategy and that access to banks’ balance sheets has become more challenging. Since the beginning of the year, all managers in this space have delivered strong risk-adjusted returns, while being positively exposed to volatility. 

Emerging markets

The top-down macro consensus on emerging markets seems to change from month to month. Hence, many of the managers we track seem to be more focused on idiosyncratic investments that are more immune to deglobalisation rhetoric. Again, discretionary managers have tended to perform better than systematic strategies since the beginning of the year. Long Brazilian rates seems to be the only consensual and crowded trade among macro managers. 

Risk arbitrage - Event-driven

Event-driven managers were negative on average during the month. Merger arbitrage books suffered due to a popular deal break (Scout 24) and to spreads widening in the risk-off market. The month provided a good opportunity for managers who were light on risk to load their books at wider spreads. Risk conscious managers continue to favour deals originated in the United States. They tend to avoid the UK, pending greater clarity on Brexit, and will require a higher risk-reward ratio in Europe to compensate for political risk and will try to avoid Asian deals for fear of regulatory complications. Nonetheless, managers are optimistic about the outlook for risk arbitrage on average, due to a supportive business environment combined with benign financing conditions and the willingness of corporate management teams to fight for sources of business growth.

Distressed

We still believe that we are in the late stages of the credit cycle. The 2019 risk-on environment reversed most of the spread-widening seen during Q4 2018. Distressed and stressed strategies are currently tending to overweight their portfolios with hard-catalyst investment opportunities that are diminishing the negative impact of beta. Managers are raising cash levels in order to reserve firepower with which to reload the portfolio with new issues hitting the distressed market. We are closely monitoring distressed managers, due to the potential of high expected returns, but remain broadly on the side lines. 

Long short credit & High Yield

Despite an increase in volatility, spreads are still heading in the same direction supported by the chase for yield. Hence, we remain underweight, as there is limited comfort in being short the credit market where there is strong demand and the negative cost of carry is relatively expensive.