FRM Viewpoint - July 2018
- The HFRX Global Hedge Fund Index fell -0.15% in July, bringing its YTD return to -1.00%.
- Hedge fund performance was more muted and driven more by beta than by alpha, although returns to Value factors performed positively globally.
- On the whole, risk asset strategies in equities and credit performed better in July, helped by a strong earnings season and generally rising markets.
July continued the difficult year for hedge fund performance, with mixed performance across strategies (as has so often been the case in 2018). On the whole, risk asset strategies in equities and credit performed better, helped by a strong earnings season and generally rising markets. Relative Value struggled, due to a hangover from the quantitative market neutral sell-off in late June and the underperformance of Event Arbitrage strategies around high profile deal breaks. Macro strategies were generally mixed, as markets reversed some of their June moves which hurt some trend following strategies.
Starting with equities, as expected, managers with higher equity market net exposure generally did better in July as markets rose, with US exposure proving to be the most fruitful. Managers are generally slightly more bullish than they have been for some time, supported by the apparent resilience of macro data and corporate earnings twinned with the fact that the general risk reduction environment of the first six months of the year means that some of the ‘fast money’ from markets may have been flushed out already. Alpha generation in non-directional managers was muted but generally positive, again supported by the earnings season. A notable detractor on the month was a social network company, which is well held by the hedge fund community and whose shares plunged after missing top-line estimates.
In a risk on month supported by improved sentiment, global credit markets rallied alongside of equities while US treasury yields were higher. Notably, after lagging for the past two months, EM and European credit markets posted healthy returns. US investment grade credit also showed some strength after underperforming for most part of the year. New issuance in US high yield continued to be driven by a decline in refinancing activity leading to one of the slowest months in the last five years. Corporate Credit managers were generally positive in the month but returns were more modest compared to June with few meaningful single name performance drivers. Several distressed credits and equity reorg names that had positive idiosyncratic news in June continued to see positive momentum. Managers with larger reorg/value equities exposure outperformed. Credit shorts were a drag on performance.
In Structured Credit, it was another month of relatively muted price moves with spreads stable across most securitized products sectors. Private student loans saw some renewed interest as there was a large block that traded on a bid list and there were a number of other secondary trades. Otherwise, trading activity was light in the month. Corporate and CMBX hedges were a drag on performance for some managers. Overall, it was another month that was largely driven by principal and interest income.
During the month, risk arbitrage had mixed performance. Overall, deals are progressing at a healthy pace towards completion and the pipeline of new deals remains robust. Vertical integrated deals and cross border deals remained the focus of attention during the month. In vertical integrated deals, the bidding war for a media company ended with one bidder (a telecommunications company) dropping its offer and focusing on purchasing a newscaster company instead. Focus has now shifted on whether another bidder (a media company) will top the telecomm company’s offer for the newscaster especially after the company reported attractive sales and subscription numbers during the last week of July.
A telecommunications equipment company/a global semiconductor manufacturer deal break was a notable detractor across the sector during the month of June. The former walked away from its bid to acquire the latter as the Chinese regulators failed to give their sign off given the mounting trade tensions between the US and China. As a result, the semiconductor company sold off and managers across the sector reduced exposure.
In Statistical Arbitrage, returns have stabilized after a difficult June, but haven’t rebounded as strongly as we have seen in previous dislocations. However, there was a danger that the poor performance in June might have led to a run on the more liquid products trading quantitative equity market neutral strategies, which in turn could have led to deleveraging, which it appears has not happened. More broadly, managers in this strategy continue to find it difficult to add value while stock specific volatility remains so low. It may be a natural output of the fact that investors are increasingly accessing markets through passive or factor based products, rather than active managers, therefore most of the flow impact on markets is leading to market or factor volatility, rather than single stock volatility (as would be the case with higher volumes of active management).
CTA managers saw gains in equities as they tend to still hold long exposure to the asset class. Most other asset classes detracted in July. The main differentiator between the better and worse performing managers was the speed that they were able to re-enter and build up US equity positions into the rally. Across the board managers are still close to maximum levels of short FX exposure (versus a long dollar position), which detracted from performance during the last third of the month as the dollar softened.
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 +0.50% in July bringing YTD returns to +2.77% …||- A Telecom/ Semiconductor transaction became a high profile victim of the ongoing US-China trade dispute during the month …||<> Announced M&A deals remained strong in July while trade tensions between the US and China escalated and economic data outside of the US moderated …|
|<> Spreads on deals with regulatory approval risk widened.||+ Managers have increased exposure to vertical transactions in the health care sector over the last quarter||<> Broad themes across the space are related to regulatory risk, bidding wars and vertical transactions.|
Equity Long-Short (ELS)
|<> Hedge fund performance was more muted and driven more by beta than by alpha, although returns to Value factors performed positively globally …||- Hedge fund managers have struggled to make gains from Japan through the first half of the year …||+ July saw equity markets recover and in the US prices approached the highest ever level (recorded in January of this year) …|
|+ A world of higher rates and higher volatility may be beneficial for hedge fund alpha.||- Investors were quick to punish stocks that missed earnings or downgraded forecasts, particularly if those stocks had been performing positively over the YTD.||+ Most managers note that the strength of the corporate landscape has left developed markets looking less expensive than they were at the start of the year.|
|<> Broad credit market spreads have remained anchored despite the uptick in equity market volatility as such limiting the availability of stressed/distressed credits …||+ In the Puerto Rico muni bond complex, PREPA bonds staged a strong rally on the announcement of a preliminary deal between the Oversight Board and the creditors …||+ Default activity remained fairly benign for another month with only one default on USD 670mm of US high yield bonds and loans …|
|+ Our base case remains carry-driven returns in the near-term, which in the context of fixed income alternatives still look reasonable.||<> All of the 21 JPM US HY industry groups were positive with Healthcare and Metals and Mining outperforming while Consumer Products lagged.||- July saw a YTD low in convertible issuance with USD 3.4bn coming to market globally.|
|+ Managers with a focus on fixed income and currency markets are expected to outperform in this highly dynamic and changing macroeconomic environment …||- The offshore Chinese yuan spot (USD/CNH spot) traded to its lowest level against the US dollar since May 2017 …||+ Positive second quarter US GDP growth, strong US non-farm payrolls data and notable corporate earnings led to the S&P 500 recording its best monthly return since January …|
|<> Currency markets were range bound in developed markets but EM currencies experienced higher volatility and high dispersion.||- Turkey continued to underperform, where an inflation print of 15.4% failed to trigger any monetary response from the central bank and the Lira continued its weakening trajectory.||+ Divergent monetary policy, differing regional growth outlooks and unique regional politics continue to bolster the global macro outlook.|
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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