FRM Viewpoint - August 2018
- The HFRX Global Hedge Fund Index rose 0.45% in August, bringing its YTD return to -0.55%.
- Hedge funds generated mixed returns in August, but in general alpha was better in Europe than the US and Asia.
- US yield curve continues to flatten, raising the spectre of potential inversion.
- Divergent monetary policy, differing growth outlooks and unique regional politics continue to underpin the global macro outlook.
The pattern of mixed performance across strategies culminating in overall lackluster hedge fund returns has been quite persistent this year and August was no exception.
Equity Long-Short managers continue to struggle to find any traction on for alpha generation, with mixed returns depending on regional and sector exposures. Following a wobble in June and July, US tech stocks returned to market leadership, and hedge funds with more of a Value bias found it more difficult to make returns through August. One area where this was not as prevalent was Japan, where the recovery to valuation risk factors continued through the first three weeks of August. More broadly, Pan-Asian managers generally had a very difficult month as Chinese stock volatility increased on continued fears around the need for deleveraging and concerns around Turkey leading to contagion in other EM stock markets.
The divergent performance between US and European stocks during the month means that beta was positive for some managers and negative for others, and in particular, two global managers with similar net exposures may have experienced very different performance depending on where their net exposure was concentrated.
Global macro managers were mixed but some patterns were clear, primarily the pressure on emerging markets risk assets which led to the underperformance of those with more constructive positioning in EM and vice versa. Elsewhere, the mid-month reversal in the USD and its temporary bout of weakness generated some P&L volatility for those that maintain a long USD stance. In the managed futures space, long equity positioning was helpful while long USD against other developed market currencies was a detractor.
August was a positive month for Managed Futures managers in aggregate, but there was quite a range of results. By asset class, each of Equity, Commodity and FX trading was positive, while Fixed Income exposure generally detracted. Within commodities, almost all of the main positions that managers held were positive (quite a rare occurrence in a sector that has lower average correlations between sub-sectors). Short Agriculturals (particularly Soy) and short precious metals were positive drivers for many managers. Energy was slightly more mixed, but those who maintained the long position from previous months had the most positive results. In Equities, managers remain long across most regions, which worked in August. There is some dispersion in exposures though, with most managers now short the UK, while European exposure is also mixed. In FX, the net short exposure to currencies remains at elevated levels, with few major currencies where managers are long given the strength of the USD this year. Fixed Income was the only negative sector, with the positive performance from long European bonds offset by losses from short US bonds.
In Credit, despite weakness in EM corporates and sovereigns and stress in EM FX, strong technicals (coupons, calls/maturities, muted issuance), resulted in a fairly stable month for US high yield. Investment grade markets (along with higher-rated HY) in the US were also supported by a rally in Treasuries. The one notable exception was the US HY retail sector which repriced lower on earnings from several retailers that showed ongoing challenges in the space. Corporate Credit manager performance was modest and mixed in the month. Puerto Rico muni bonds were a positive contributor on the announcement of an agreement with another group of creditors. Some managers benefitted from longstanding shorts in the retail sector while others saw some losses from longs in the energy sector.
In Structured Credit, legacy MBS spreads continued to be relatively stable on strong residential credit fundamentals while CMBX spreads widened, especially those with concentration in malls exposed to certain retailers. Spreads were also modestly wider in the credit risk transfer sector. Structured Credit manager performance was largely positive in August driven by carry income given the mixed month for spreads across sectors.
During the month Risk Arbitrage had mixed performance. Overall, it was a quiet month with deals progressing toward completion and the pipeline of new deals remains robust in our view. In vertical integrated deals, healthcare related transactions have garnered attention. Shareholders of an insurance company and a prescription benefit plan provider voted to approve the firm’s merger. This merger transaction along with a retail pharmacy company’s pending acquisition of a managed care company both have outside parties voicing opposition to these mergers and they are currently pending the Justice Department’s approval. A computer company’s efforts to buy out its tracking stock in its effort to go public also was a focal point during the month. The proposed package faced criticism in August by activist investors and hesitation from shareholders.
In Stat Arb we saw notable results from technical and Machine Learning strategies in equities while challenges continue with weaker results in fundamental strategies, especially in Emerging Markets, with China, Korea & Turkey being some of the more difficult markets this month. There is some excitement in the quant community around expansion of China A shares given progressive MSCI Index inclusion. We’ve seen new China A market neutral funds pop-up in the last couple of months and expect to see more.
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 +0.19% in August and up +2.63% year-to-date …||<> Longer term managers are shorting their trading orientation with a view that market volatility will increase in the fall …||+ Deal volume experienced seasonal moderation in August but 2018 is still on track to be one of the best years in terms of deal volume in recent years …|
|+ Healthy M&A volume has been driven by an increase in transactions larger than $5 billion.||- Market weakness and reduced activity in Asia led to spreads widening across merger arbitrage, hold co trading, ADR trading and A/H trading.||<> Cross boarder and vertical integrated deals continue to be a focus.|
Equity Long-Short (ELS)
|- Japan was a particularly difficult market to trade during the month, with a strong Value bias during the first half of the month quickly switching to a Momentum bias …||+ Following a pull back in some technology names on weak earnings announcements in July, the sector returned to the top of the rankings …||- A number of ELS managers have commented that there are multiple risks to the current market in the immediate term, namely European politics (particularly Italy), the growing EM crisis …|
|+ ELS managers with a Growth bias to their long books have significantly outperformed their Value biased peers over the course of 2018.||<> Despite the fact that US stocks are more expensive than European stocks on a P/E multiple basis, few hedge fund managers are explicitly long Europe and short US.||<> Hedge funds generated mixed returns, but in general alpha was better in Europe than the US and Asia.|
|<> Broad credit market spreads have remained anchored despite the uptick in equity market volatility as such limiting the availability of stressed/distressed credits …||+ Most Puerto Rican debt traded higher in August on the back of several positive developments for bond holders …||<> August primary market activity remained light on both a gross and net basis with US HY issuance of $16.0bn ($8.1bn net) and leveraged loan volume of $39.0bn ($27.3bn ex-refi/repricing) …|
|+ Structured Credit managers were positive with a combination of carry, trading, and mark-to-market gains partially offset by rates and credit hedges.||<> Higher-rated credits outperformed in August as Treasuries rallied with CCCs (+0.56%; JPM) underperforming BB-rated bonds (+0.94%).||+ US leveraged credit markets benefitted from new S&P 500 highs, HY and loan fund inflows, and light issuance.|
|+ Managers with a focus on fixed income and currency markets are expected to outperform in this highly dynamic and changing macroeconomic environment …||- Emerging Markets have underperformed significantly, suffering from expanding betas on the downside …||+ US equities continued one of the longest bull runs in history, boosted by strong domestic macro data …|
|<> The US yield curve continues to flatten, raising the spectre of potential inversion.||- Turkish Lira depreciated a further 25% on US threats to double steel and aluminium tariffs on Turkish exports and the perceived reluctance by the Central Bank to hike rates.||<> The monetary policy stance by several EM Central Banks has turned from easing to tightening in response to the speculative attack on the currencies.|
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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