FRM Viewpoint - January 2018
- The HFRX Global Hedge Fund Index rose +2.45% in January.
- Overall, hedge funds had a positive month, with losses in the last few days partly blunting what was still a notable month across nearly all strategies.
- Equity markets rallied globally through most of January, before giving back some gains in the last few days of the month (and then selling off significantly in February).
Overall hedge funds had a positive month in January, with losses in the last few days partly blunting what was still a notable month across nearly all strategies. The best performing themes were beta and single stock momentum exposure in equities, trend-following in FX, and rates and a convergence of Event Arbitrage spreads. Credit managers were more muted, but still produced positive returns on average.
Given the strength of the S&P 500 through January, US ELS managers generally benefited from any bullish positioning they held and so performance has mostly been a function of net exposure. The commencement of the Q4 earnings season has introduced some dispersion into the market but generally longer-biased managers have performed the best. While net exposures remain elevated, bolstered by a surge of earnings revisions, managers are remaining alert to any events that could lead the rally to unwind or to a factor or sector rotation. Sentiment is therefore cautious despite high exposure levels and the ebullience in the market.
European ELS managers also performed positively in January despite more muted stock index returns. The main driver of returns for these managers was single stock momentum, which continued its notable run of the previous month.
Many Macro managers are buying into the synchronized global growth theme and are concerned about rising inflation risk, which is broadly reflected in positioning long inflation breakevens and short nominal fixed income. These trades generally benefited managers in January, along with longer-term macro trends which have extended further.
CTAs were generally positive in January driven by two overriding themes – short dollar (which correlated with the long equities and commodity themes), and short rates. Equity has contributed around half of the gains. Futures managers trading more diversified books by strategy have underperformed peers.
Regarding the outlook for Macro managers, 2018 has the potential to be driven by a confluence of themes, including potential inflation overshooting, extended USD weakness and continued removal of Developed Markets’ central bank accommodation. A key consideration for the USD outlook is the continuing breakdown in the long-standing correlation between yield differentials and FX levels. One interpretation of this is that USD inflows to purchase US assets are being overshadowed by USD outflows for funding purposes, which could be reflective of strong global capital demand in a risk-seeking economic environment. Another negative catalyst for the USD is the significant amount of domestic and international USD bond issuance that is expected in 2018, on the back of a 44% rise in Emerging Markets USD-denominated issuance in 2017. As such a weaker USD may provide positive support for global financial conditions and risk assets.
January was a mixed month for credit markets as flat to positive performance for US high yield and leveraged loan markets outperformed the rate sensitive investment grade markets which sold off in conjunction with sovereign yields globally. High yield spreads tightened and loans benefited from floating rate coupons. Within high yield, lower rated paper (B and CCC) outperformed as did a handful of higher spread sectors (Retail, Telecom) and energy credits, buoyed by rising oil prices. Corporate credit managers were mostly flat to positive in January. Managers continued to benefit from more gains in a distressed energy name that had positive idiosyncratic developments the prior month. Other areas that generated gains included stressed telecom and healthcare names and Puerto Rico exposure which rebounded in January.
Structured credit managers generally reported positive performance driven by carry and spread tightening. Specifically, non-agency RMBS contributed as credit risk transfer remittance reports showed better than expected delinquency rates for hurricane affected areas and a number of legacy RMBS deals were called without trustee reserves. Private student loans also benefited against a favourable fundamental backdrop, while short positions generally detracted from performance.
January was a positive month for Event Driven strategies. Strong equity markets, fallout from the tax reforms and increased confidence in global growth boosted returns from Special Situations. It also led to a broad tightening in merger spreads. Returns were generally diversified across many positions, with little on the detracting side. While Relative Value situations generally performed positively throughout the month, one well owned position in particular detracted towards month end as rumours circulated that the parent company might be considering an IPO or a deal to buy the subsidiary’s stocks that it does not already owned. Theoretically this should not be negative for the relative value trade, but uncertainty and crowding have contributed to make this a significant deleveraging event and offset some positive gains accrued during the month.
Global deal activity has made a notable start this year with USD 400bn of transactions announced, including USD 130bn proposed (Bloomberg as of 01/30). While the sustainability of deal making may be questionable given current valuation levels, the recent pick up in announced transactions (Q4 2017 and January 2018) has provided managers with potentially fertile ground for the coming months.
In Statistical Arbitrage, it was an encouraging month for most factor based strategies, in large part driven by returns from cross sectional momentum. Technical strategies have been positive as well, but this is not an environment (strong cross sectional momentum and low volatility) in which we would usually expect these strategies to thrive.
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 +1.6% and HFRI Merger Arbitrage Index was up +0.95% in January …||- One well owned position detracted towards month end as rumors circulated that the parent company was considering an IPO or buyout of the subsidiary’s shares that they don't already own …||+ Global deal activity has made a strong start this year with USD 330bn of transactions announced, not including USD 155bn of proposed deals …|
|+ Performance in equity strategies was generally positive from both the more technical managers and the fundamental strategies.||<> Six deals were announced in the biotech sector during the month for a total of USD 25bn.||+ The recent pick up in volatility has led to some spread widening which could allow managers to deploy further capital as they see trading opportunities arise.|
Equity Long-Short (ELS)
|<> January was generally a positive month for ELS returns, driven primarily by beta in all regions and with the best alpha performance coming from Europe …||<> In Japan, many hedge funds avoid Robotics and Automation stocks on the long side of the book and some explicitly hold shorts in these names …||<> Equity markets rallied globally through most of January, before giving back some gains in the last few days of the month …|
|+ Earnings seasons were generally positive, with robust earnings growth across Developed Markets.||- European ELS managers generated more alpha than their US counterparts in January.||<> Unlike other large-cap indices in Developed Markets, the Eurostoxx 50 saw a sharp dip into year-end.|
|+ After the lowest annual default volume total since 2013, US default activity remained muted in January …||<> Lower-quality credits continued to outperform in January (CCCs +1.1%, BBs -0.02%; JPM) …||+ US leveraged credit markets posted positive total returns in January (loans +1.1%, HY +0.7%; JPM) …|
|+ Corporate Credit managers had positive returns in January driven by gains in stressed/distressed credits.||+ 17 of the 21 JPM US HY industries were positive last month.||+ Outright convertible bonds tracked equities higher and were positive across all regions (in USD terms).|
|<> The USD DXY index has fallen nearly -14% since the December 2016 highs, and is now at the lowest level in over three years …||<> Macro managers are focusing on the relationship between rates and the USD …||<> January was an active month for macro market trends, with US/Europe/UK yields all extending 25+bp sell-offs into the final week of January …|
|+ A weaker USD may provide positive support for global financial conditions and risk assets.||+ Macro managers maintained longs in global breakevens, as well as yield curve steepening trades.||<> FX volatility rose notably, with soundbites from the World Economic Forum in Davos causing the USD to whipsaw.|
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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