FRM Viewpoint - April 2018
- The HFRX Global Hedge Fund Index rose +0.09% in April, bringing its YTD return to -0.93%.
- Market volatility persisted throughout April as geopolitical headlines, mixed economic data prints and divergence in central bank outlook kept investors unsettled.
- Hedge funds experienced a mixed month in April, with Global Macro and Relative Value strategies benefiting from higher levels of volatility to generate better returns.
Hedge funds experienced a mixed month in April, with Global Macro and Relative Value strategies benefitting from higher levels of volatility to generate better returns, while company specific alpha was hard to generate for Equity Long-Short and Event Arbitrage managers. Credit strategies generally had a quiet month despite volatility in fixed income markets.
Much of the difficulty in Equity Long-Short strategies stemmed from a series of factor rotations and general investor de-risking through the first part of the month. Managers reported specific losses from exposure to Momentum factors, whereas Value exposure recovered from a difficult first quarter, particularly in Japan. As might be expected in a month with positive equity market returns, managers with higher net exposure generally performed better.
On the whole the developed market earnings season was generally positive and a source of alpha for hedge fund managers. Stocks are now exhibiting larger moves on earnings beats and misses, as investors move into stocks that are expected to perform better in the new monetary regime. Crowded longs/shorts that miss/beat earnings respectively were a source of significant negative alpha.
Event driven strategies remained under pressure in April as risk arbitrage performance continued to be a headwind for a number of managers and resulted in negative to flat performance for the month. Risk arbitrage losses were driven by further negative developments in deals requiring Chinese regulatory approval. A semiconductor manufacturing company and a telecommunications equipment company deal was one of the largest negative contributors across the strategy as the companies had to withdraw and refile their application for approval with Chinese regulators as US and China trade tensions persisted.
On the positive side, other core risk arbitrage positions benefitted from idiosyncratic company specific developments that led to tighter spreads. Deal activity was quiet in early April but picked up in the last few days of the month. Highlights for April included an increased offer of USD 64bn for Shire from Takeda Pharmaceuticals and Comcast’s USD 31bn offer for Sky PLC, topping a prior offer from 21st Century Fox.
It was a fairly uneventful month in the credit markets despite the late-month volatility in equities and a backup in treasury yields. US high yield spreads hit multi-year lows intra-month but retreated off those levels as rates increased later in the month. US leveraged loans and high yield were positive for the month while investment grade continues to underperform driven by longer duration. Within US high yield, lower-rated credits have held up relative to higher-rated parts of the market, again driven by interest rate risk. Telecom, Retail and Energy (driven by continued strength in the crude oil market) are the best performing sectors while the Automotive sector is a notable laggard.
US high yield saw the largest weekly inflow in April since December 2016 after seeing noteworthy outflows over the prior several weeks. Loan funds continued to see investor interest. Primary market activity in April was below average across both loans and bonds. Securitized products were once again largely immune from the late-month selloff in US equities and treasuries. Collateralized loan obligation mezzanine debt (due to increased supply and other fundamental factors) and lower-rated credit risk transfer a deal saw some widening but otherwise credit spreads were stable across most sectors.
April returns across Corporate Credit managers were mostly positive but there was a lack of idiosyncratic P&L drivers. Structured Credit managers were also positive for the month primarily driven by principal and interest income. Relative Value trading (structured credit vs. corporate credit, relative value rates and volatility trades, etc.) was a source of alpha generation for some managers.
Macro performance was mixed in April, with positions in US rates generally working, alongside long crude oil which is gradually finding its place in managers’ portfolios. Emerging Markets underperformed, particularly on the equity side, with higher US rates finally appearing to be reaching a tipping point where they start to hurt spread assets (though High Yield remains very resilient) and higher beta plays.
Trend following had a generally positive month from short US rates and long energy commodities, while suffering from currency exposures, in particular long EUR and GBP. USD remains stable with a weak undercurrent in the face of widening interest rate differentials, but managers have adjusted positions and largely abandoned the long USD trade.
It was a positive month for Statistical Arbitrage strategies. Fundamental strategies bounced back from a weak period in March and posted positive returns. This included a bounce in some of the Asian valuation based strategies which had appeared stretched over the first quarter of the year. Europe continues to be a strong region for these strategies. Technical strategies were more muted but still positive. There was quite large divergence in performance of the more technical managers, but performance from diversifying and futures based statistical strategies was positive.
Summary of performance drivers by strategy
|Key:||+ Positive factors and/or drivers||<> Neutral factors and/or drivers||- Negative factors and/or drivers|
|Alternative risk premia||Trade examples1||Environmental factors|
Relative Value (RV)
|+ The HFRI Event Driven Index was up +0.4% in April bringing YTD returns to +0.6% …||<> Stub trades and other equity special situations trades were mixed but with an overall negative skew as positions in technology companies experienced losses …||+ Global M&A activity continued to perform positively in April as the dollar volume of announced deals was up 103% YOY (GS) …|
|- It was a challenging month as event driven strategies had to contend with large losses in a few, widely held, risk arbitrage and equity relative value positions.||+ Risk Arbitrage trades generally performed positively in April.||- M&A completion rates continued to fall in April.|
Equity Long-Short (ELS)
|- April was quite a difficult month for ELS strategies, as a number of the factor exposures that had worked in the first quarter, such as momentum and size, started to roll over in April …||- Managers generally held quite crowded short exposure in stocks which had been falling steadily through the first quarter …||- Hedge fund managers generally struggled in April despite rising markets due to a fairly sharp reversal in the momentum factor …|
|+ Despite the difficulty for hedge funds, most equity market indices rallied during the month.||- Most global hedge funds run with a slight overweight net exposure to the US, which tended to be a drag on performance in April.||<> The landscape of higher US rates, higher oil prices and higher inflation expectations has finally started to lead to a higher dollar price.|
|+ In the face of rising treasury yields, US and European high yield markets were positive in April supported by a comparatively more stable equity market backdrop vs. the prior two …||<> Higher-rated credits (BBs +0.13%) underperformed in April driven by longer duration vs. lower-rated names (CCCs +0.92%) …||<> US HY and leveraged loan primary market activity saw a month-over-month decline in April despite the firmer market backdrop …|
|+ Rates were higher, volatility lower and credit spreads were generally tighter.||+ There were gains from commodity-related equities.||+ Default activity was light in April with only two companies defaulting on USD 1.1bn of loans and bonds.|
|<> Market volatility persisted throughout April as geopolitical headlines, mixed economic data prints and divergence in central bank outlook kept investors unsettled …||- Emerging Market equities were down in April as the strengthening US Dollar was a headwind globally but in particular for emerging markets…||- US economic data remained firm as the unemployment rate held steady in March at 4.1% and wage growth continued …|
|<> The most meaningful market development was the strengthening of the US dollar against most currencies both in developed and emerging markets.||<> Argentina's stock markets and currency came under pressure towards the end of April as the central bank sold over USD 4bn to try and support the peso.||<> Energy was the best performing commodities sector as geopolitical concerns increased due to uncertainty about whether the US would withdraw from the Iran nuclear deal.|
The above summary is based on FRM’s opinions on performance drivers across the hedge fund industry and is not representative of the investments made by FRM. 1. The herein mentioned examples are intended as illustrations of typical investment consideration and/or strategy implementation. It should not be construed as indicative of potential performance of the fund or strategy or any investment made by the fund. It does not constitute a recommendation or investment advice or solicitation to buy or sell any particular securities and should not be considered as any investment advice or research of any kind. There can be no guarantees that similar opportunities will be available in the future or that any opportunities identified will provide similar results.
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