FRM Viewpoint - February 2018
- The HFRX Global Hedge Fund Index fell -2.42% in February, reducing its YTD return to -0.04%.
- Hedge fund performance in February was quite mixed, with some more acute negative observations primarily in the quantitative space.
- Equity markets sold-off heavily in the first part of February on inflation concerns and the rising cost of capital, particularly in the US.
Hedge Fund performance in February has been quite mixed, with some more acute negative observations primarily in the quantitative space. Nonetheless, given the performance of underlying asset classes, the downside capture exhibited by most strategies was within expectations and in some cases rather encouraging.
Given the equity market volatility seen in the first half of the month, performance of Equity Long-Short hedge funds was decent. In particular, some European ELS managers made money from alpha and factor exposures, such as single-stock momentum which held up well through the market turbulence, to offset losses from beta exposures. In general, there was wider dispersion of returns than in previous months, which is not surprising given the increased market volatility. Managers generally reduced risk through the market sell-off (both net and gross), but only back to Q4 2017 levels, and in most cases risk remains elevated relative to the average of the last 12 months. Looking forward, managers remain largely bullish on equity markets, noting that the strength of GDP and earnings should be sufficient to carry equity markets to new highs despite fears over inflation and higher rates. However, all managers believe we should see a more volatile equity market landscape in 2018 as periodic shocks punctuate the return to more normal monetary policy.
Macro managers had mixed results and generally were able to maintain year-to-date performance in positive territory. Many benefited from the move higher in rates as they keep sizable exposure in rate payers as well as yield curve steepening trades. Some of the pro-risk positions that posted gains in January experienced a reversal early in February, particularly long equity exposure and long emerging markets currencies, with a moderate overall impact on performance. Inflation remains a key focus point as well as the relationship between interest rate differentials and the USD, which appears weaker than usual so far in this cycle.
CTAs experienced sharp drawdowns as their long equity positions suffered in the first half of the month while commodities and currency exposures added to losses. In commodities, losses originated from long exposures to energy as well as shorts in agriculture while in currencies the culprit was primarily a short USD stance. Exposures have been reduced meaningfully as expected, primarily in the long equity risk given the rise in volatility and the reversal in price action.
February was generally a positive month for Merger Arbitrage strategies. The first part of the month saw some widening in merger spreads, but there was not a sense of panic and managers opportunistically added to positions with enhanced risk reward characteristics. The second part of the month was strong as several large deals saw positive catalyst materialising. NXP benefited from Qualcomm’s increased offer and Sky traded up on news that Comcast is outbidding Fox. Relative Value strategies on the other hand had a poor second half of the month, with several spreads drifting further away from convergence. There was no specific driver but we sense some capitulation in that space. Managers remain upbeat about the opportunity set in Merger Arbitrage, with large deals progressing and corporate firepower at healthy levels.
It was generally a negative month for the corporate credit markets against the backdrop of higher equity market volatility and a backup in government bond yields. Leveraged loans outperformed high yield for another month as there was continued demand for floating rate risk resulting in inflows into loan funds while high yield bond funds saw heavy outflows. Longer-dated high yield as well as investment grade bonds lagged meaningfully given the selloff in rates. Structured Credit managers generally reported flat to positive returns as any spread widening was absorbed by the portfolio carry. Most securitised assets held up reasonably well during the early month’s volatility while there was some weakening in the synthetic CMBX indices which many managers use as a hedge against their long portfolios. The legacy RMBS sector was stable while there was some early month weakness in the higher beta credit risk transfer sector as well as modest widening for CLO BBs/BBB- bonds. The Puerto Rico muni bond complex continued to build on January gains as a revised fiscal plan submitted in February, unlike the January draft, included some cash available for debt service in the coming years. Corporate credit managers were flat to modestly negative, lower-rated and distressed credits mostly held up better than more liquid, on-the-run single name shorts and index hedges. Credit Long-Short managers outperformed outright Distressed managers as exposure to value and reorg equities had a negative impact on the latter.
Statistical arbitrage managers broadly posted negative performance. The worst impacted managers were clearly those trading futures strategies, both faster futures strategies and slower trend based strategies were large detractors. Interestingly, it seems that the more diversified managers weren’t any better than the generic trend strategies, on a volatility adjusted basis. Even within equity based strategies there was a pretty clear divergence between fundamental strategies and faster technical Statistical Arbitrage. Fundamental strategies were impacted by what seemed to be a moderate risk reduction in the space a few days after the moves in the broader index. Meanwhile technical Statistical Arbitrage strategies were largely unaffected. We would anticipate these strategies to outperform in a more volatile environment.
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 month was challenging for Special Situations, as those tend to exhibit higher beta to equity markets than hard catalyst situations …||<> Despite shakier market conditions, deal activity remained stable and USD 370bn of transactions were announced during the month …||- HFRI Event Driven Index was down -0.64% in February bringing YTD returns to +0.69% …|
|+ February volatility did not change managers’ investment thesis.||- The Dell spread trade had knock on effects on other popular Relative Value spreads.||+ Aggregate M&A firepower – the sum of a company’s readily available cash and debt capacity within its credit rating – is currently estimated at USD 5.0-5.5 trillion for the S&P 500 (excluding financials and utilities).|
Equity Long-Short (ELS)
|+ On a market neutral basis, most common factors such as momentum and size performed reasonably well through the crisis …||- One large single stock loss for a number of European ELS managers was the short exposure to a specialty finance company …||- Equity markets sold off heavily in the first part of February on inflation concerns and the rising cost of capital, particularly in the US …|
|- The spike in volatility was exacerbated by the unwinding of short-volatility products.||+ A number of managers noted that the economic backdrop remained strong, and as such were ‘buying-the-dip’ in the middle of the month.||+ Markets recovered in the middle of the month before sagging again into month end.|
|+ Corporate Credit managers benefitted from convertible arbitrage exposure in February …||<> All but one (Broadcasting +0.02%) of the 21 JPM US HY industry groups were negative for the month …||+ February was a risk-off month that saw a significant pickup in equity market volatility and mostly negative total returns for the global credit markets …|
|<> Convertible new issuance also dropped from Januarys record pace to a more modest USD 3.7bn (BAML).||- Reorg. equities were generally the largest detractors in February.||- HY bond funds reported heavy outflows (USD -9.4bn) in February resulting in the largest ever 5-month cumulative outflow.|
|- During the first week of the month there was a meaningful spike in equity volatility and a sell-off in equity markets which generated limited contagion to other asset classe …||+ Soybeans continued a strong rally on the back of a drought in Argentina …||<> February’s price action across markets seems to signal that the era of low inflation, easy financial conditions and low volatility is ending …|
|+ Emerging Marketers currencies were quite resilient in the higher volatility environment.||<> Macro managers maintain a tactical approach with a modest short USD bias.||+ Money markets have regained some attention with three month Libor climbing above two percent.|
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.
Opinions expressed are those of the author and may not be shared by all personnel of Man Group plc (‘Man’). These opinions are subject to change without notice, are for information purposes only and do not constitute an offer or invitation to make an investment in any financial instrument or in any product to which the Company and/or its affiliates provides investment advisory or any other financial services. Any organisations, financial instrument or products described in this material are mentioned for reference purposes only which should not be considered a recommendation for their purchase or sale. Neither the Company nor the authors shall be liable to any person for any action taken on the basis of the information provided. Some statements contained in this material concerning goals, strategies, outlook or other non-historical matters may be forward-looking statements and are based on current indicators and expectations. These forward-looking statements speak only as of the date on which they are made, and the Company undertakes no obligation to update or revise any forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those contained in the statements. The Company and/or its affiliates may or may not have a position in any financial instrument mentioned and may or may not be actively trading in any such securities. This material is proprietary information of the Company and its affiliates and may not be reproduced or otherwise disseminated in whole or in part without prior written consent from the Company. The Company believes the content to be accurate. However accuracy is not warranted or guaranteed. The Company does not assume any liability in the case of incorrectly reported or incomplete information. Unless stated otherwise all information is provided by the Company. Past performance is not indicative of future results.