FRM Viewpoint - June 2018
- The HFRX Global Hedge Fund Index fell -0.19% in June, bringing its YTD return to -0.41%.
- Trade frictions primarily between US and China are having an impact across markets.
- Hedge fund performance was mixed in June, with Credit and Macro strategies performing positively and Quantitative strategies underperforming Equity strategies.
Hedge fund performance was mixed in June, with Credit and Macro strategies performing positively and quantitative strategies such as Statistical Arbitrage and Alternative Risk Premia underperforming Equity strategies, both Equity Long-Short and more Relative Value focused strategies generally produced positive returns. The shape of returns during the month was somewhat similar to May, with a positive first half to the month tempered by rising volatility in the last two weeks.
It is perhaps illustrative of the uncertain nature of equity markets that the Equity Long-Short managers that we follow have been moving their risk allocations more frequently than usual. Managers who are comfortable with a variable market bias (i.e. who may run net long or net short depending on circumstances) have generally been switching from bullish to bearish through June, finishing with more pronounced net short exposure than we have seen for some time. Similarly, aggregate net long exposure to equity market for the Equity Long-Short universe has also been coming down, based on the data that we have. Factor attribution of Equity Long-Short managers was hard in June, as different periods saw different behavior. The first half of the month was generally positive for Momentum and negative for Value and Quality, although Quality metrics recovered in the second half of the month as Momentum pulled back.
Event Arbitrage strategies experienced a generally positive June, helped by the closure of Relative Value spreads through the first part of the month, particularly Merger spreads and Holding Company Arbitrage spreads. Some of these spreads widened in what appears to be deleveraging activity toward the end of the month.
Statistical Arbitrage managers struggled during June. In our experience, it was the more traditional strategies that struggled, which we believe is indicative of negative flow dynamics in markets, whereas the most idiosyncratic strategies generally performed positively. For instance, Emerging Markets focused strategies produced positive performance despite the heightened volatility in those markets, with the biggest losses occurring in the comparatively sanguine US market.
Our managers in Discretionary Macro posted mixed returns with clear differentiation between defensive positioning that benefitted from short exposure across Emerging Markets and selectively in developed markets as well as Fixed Income Relative Value positions in developed markets generating gains. On the negative side managers with pro-risk exposure in Emerging Markets, primarily in FX and interest rates suffered losses.
The general view held by our Macro managers is that the Fed reaction function doesn’t incorporate any substantial sensitivity to yield curve shape because they think the flatness is explained by technical factors, primarily global QE whose importance would recede in the coming quarters. Thus the Fed is expected to focus on real economy data and continue with the hikes regardless of the yield curve shape. Ditto the European Central Bank (‘ECB’), whose announcement to stop Bond purchases seemed to have little regard for timing, coming into the midst of Italian political turmoil.
There are signs that we could be witnessing a global repricing and the sequence may have more to do with the emergence of catalysts than with relative fundamental weakness. Emerging Markets was at the forefront of the sequence as its need for financing in hard currency (twin deficits) across several countries triggered the repricing across asset classes with an epicenter in FX. When other segments of the global market landscape face catalysts for repricing they may also suffer meaningful pressure.
June was a generally positive month for the CTA industry. Despite some volatility through the month, none of the major asset classes was a major contributor on either the positive or negative side. Generally, Fixed Income and FX were positive contributors, while Equities and Commodities were a detractor. In FX, almost all managers are short currencies versus the US dollar, and the stronger US dollar trend continued (albeit with less strength than in May). Short positions in US Fixed Income more than offset losses from long European Fixed Income. In equities, long positions in the US were a positive, but these were offset by losses in Asian equity markets. In commodities, long energy related products continue to be the main detractor. Short positons in Agricultural markets were the main positive driver in commodities.
Corporate Credit, with the exception of Investment Grade, held up despite renewed global trade tensions triggering market volatility heading into month end. US high yield outperformed leveraged loans and the European high yield market. Retail and Telecom were among the best performing US high yield sectors last month. Lower-rated credits were well bid. US high yield spreads remain within striking distance of multi-year lows as secondary valuations continue to be supported by below average issuance given the competition from the loan market.
Corporate Credit managers were mostly positive in June with returns driven by several positive idiosyncratic developments including an exchange, a restructuring deal and an ‘amend and extend’ transaction given the accommodative markets. The Puerto Rico Municipal Debt complex also did positively on news of an agreement in the dispute regarding priority issues between the General Obligation (GO) and sales tax (COFINA) bonds.
Structured Credit managers were also largely up in the month as spreads across most securitised products sectors were generally healthy with weakness only in some of the higher beta sectors like Credit Risk Transfer. Some managers selectively added risk seeking to take advantage of a large portfolio sale early in the month.
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 +0.74% in June bringing YTD returns to +2.29% …||+ Vertical deals generally had a positive performance during the month …||+ A surge in US buyer activity in deal activity is notable this year…|
|<> The macro backdrop remains mixed with US interest rate rising and consumer confidence falling versus volatility moderating and marketing trending higher.||- Exposure to a semiconductor company was the leading detractor to performance amongst many in the risk arbitrage space.||+ In Western Europe M&A, the United Kingdom is the largest contributor to activity.|
Equity Long-Short (ELS)
|<> June was a mixed month for ELS strategies, with some of the more market neutral managers suffering collateral damage from the sell-off in Statistical Arbitrage towards the end of the month …||- The continued strength of the US dollar continued to put pressure on EM assets …||<> ELS managers are becoming more bearish on equity markets, although there remains a range of views on the way that markets resolve the end of the economic cycle …|
|- The most notable development in June in equity markets from a hedge fund perspective was the pull back in the momentum factor, particularly in US stocks.||- A number of managers have noted that there are now blue-chip cyclicals in the region that represent notable value as they have been sold indiscriminately over the year-to-date.||<> This is the second month in succession where volatility has picked up towards the end of the month.|
|+ US levered credit markets managed to post modest gains despite volatility in most asset classes …||<> Retail and Energy were the best performing US HY industry groups while the Automotive sector was the worst…||- US HY new issuance continued at a below average pace in June with only $16.2bn of primary market activity.…|
|+ Our base case for structured credit remains carry-driven returns in the near-term.||<> Performance in stub trades/reorg. equities was mixed.||+ Global convertible issuance was robust at $11.1bn with US leading the charge.|
|+ The outlook for global macro strategies continues to evolve towards a richer mix of active policy making across monetary, fiscal and trade dimensions which is expected to lead to higher volatility and a repricing of risk premia …||<> The technology dominated NASDAQ index outperformed the Dow and S&P indices which had greater exposure to Industrials …||+ Fears of a Eurozone breakup receded in June as the Italian populist coalition that was sworn into office made a commitment to stay in the Euro …|
|- EM currencies have been under pressure.||- Base metal and agricultural commodity prices fell sharply in reaction to the tariffs with Soybeans suffering particularly heavy falls.||<> Macro managers are looking at trade disputes as one of the main risks to the global economy and markets.|
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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