FRM Viewpoint - March 2018
- The HFRX Global Hedge Fund Index fell -0.98% in March, reducing its YTD return to -1.02%.
- Despite continued volatility in equity markets, most hedge fund strategies performed better in March than they did in February.
- We are transitioning from an era of low rates, low volatility and easy financial conditions to something that looks and feels less comfortable.
Despite continued volatility in equity markets, most hedge fund strategies performed better in March than they did in February. Given the higher levels of asset volatility, there was greater variation in individual manager returns, but several strategies eked out positive or flattish returns for the month.
In Equity Long-Short, European managers generally performed better than their US peers due to a lower aggregate net exposure and less reliance on Technology stocks on the long side of their books. The tail end of the Q1 earnings season was broadly positive for managers as stocks continue to behave more rationally in the face of good/bad news, and managers are seeing short alpha in March (which was harder to achieve in February despite the market sell-off). There were a number of days in the month that witnessed outsized returns (both positive and negative) for cross-sectional momentum. Our own opinion was that these represented rotations within the equity market rather than a deleveraging event, but these are always hard to pin-point.
March returns for Corporate Credit managers had a negative bias with a few exceptions. Managers focused on (floating rate) financial preferreds and hybrid debt outperformed. A disappointing bankruptcy asset sale of an E&P company negatively impacted returns for several credit managers while a few managers saw gains on some idiosyncratic credit shorts (e.g. healthcare names). Puerto Rico exposure was also a noteworthy contributor for some while reorg. equities were generally a detractor. Structured Credit managers outperformed in March with mostly positive (carry-driven) returns.
On the whole corporate credit markets tracked equities lower, especially during the volatile back half of the month (driven by a perceived hawkish Fed rate decision in the US and the potential for a US/China trade war as both countries announced tariffs). Leveraged loans once again outperformed high yield, supported by continued inflows into the asset class and the persistent rise in Libor. The investment grade market held up better compared to February as rates were somewhat range bound. Within US high yield, lower-rated credits underperformed and returns were negative for a significant majority of the industry groups. Retail and Energy were among the worst performing sectors. The latter was a bit surprising given the rally in oil.
March performance for securitised products was mixed with mostly stable spreads across the legacy structured credit sectors with some of the newer and higher beta sectors like credit risk transfer (CRT) experiencing spread volatility alongside corporate credit. Floating rate risk once again outperformed. Puerto Rico bonds staged another rally in March as a revised fiscal plan projected a higher surplus in the coming years.
In Macro, the widening in funding spreads have so far only affected the strategies that are closely tied to funding markets, with a net positive effect on the opportunity set for Fixed Income Relative Value and other liquidity provision strategies. There have been noteworthy moves in cross-currency basis markets and implied repos in derivatives which are relevant to managers’ positions and generally positive in March but noisy on a year-to-date basis. Emerging Markets remain resilient across asset classes on the face of Developed Market turbulence, with little beta expansion to report, primarily, in our view, due to the structural weakness of the USD which has puzzled many in the context of widening interest rate differentials.
CTA managers had a mixed month, with positive positions in Commodities and FX and a mixture of winners and losers in equities and bonds. In commodities, P&L was driven by long positions in energy commodities, particularly oil, while small long positions in gold were also positive. The largest FX positions were long euro and sterling versus the dollar, with smaller positions also long the yen versus the dollar. Equity positioning is now much more subdued than at the start of the year, with broadly short exposure to European indices (leading to positive returns in March), and still some long exposure to the US. Fixed income exposure broadly experienced losses during the month, as managers are short US government bonds, which rallied on the risk-off move through the second half of the month.
After a positive February, Risk Arbitrage gave back some gains. The spread widening felt broad-based and there were a few environmental concerns weighting on merger spreads such as i) fears around a potential trade war between the US and China leading to some widening in deals requiring the Ministry of Commerce of the People's Republic of China’s approval and ii) widening on deals requiring Department of Justices’ approval as the Time Warner/AT&T hearing started. Event RV had losses during the first half of the month but bounced back in the second part of the month as volatility picked up.
In Merger Arbitrage, deal activity was again robust in March, with ~USD 300bn of new deals being announced so far this month (excluding proposed deals; source: Bloomberg). More generally, global M&A activity has started off strong for 2018; it has reached USD 1tr already, up more than 50% from a year ago. Also, a flurry of jumbo deals have been announced.
In Statistical Arbitrage, it was a relatively volatile month. Generally, the increased volatility in markets has been a positive for technical strategies, while slower more factor driven strategies have struggled with more broader-based deleveraging and market rotations. By region, Europe continues to be a positive for the strategy, while Asia (and particularly Japan) was difficult again. In Asia, this appears to be at least partly driven by a continued struggle for Value metrics. The US was interesting, with more technical managers generally performing positively, while the slower more factor driven strategies suffered during the increased volatility in the first week of 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 down -0.5% in March bringing YTD returns to +0.2% …||<> Concerns over CIFIUS intervention had an impact on performance for the month …||- Global M&A announcements in the first quarter reached circa. USD 1 trillion, which is eclipsing the first quarter of 2000 and 2007 …|
|<> Last month was challenging for Risk Arbitrage and Special Situations while Relative Value fared fine.||- Key detractors in March included a semiconductor manufacturing company, a media company and an agrochemical company.||+ Deal activity remained strong in March despite the global geopolitical backdrop of increased protectionism.|
Equity Long-Short (ELS)
|- ELS managers had losses in March, as positive performance evaporated in the face of a significant factor reversal in the last few days of the month …||+ The top performing strategy in Japan this year has been to buy the highest PE stocks and sell the lowest PE stocks …||- During the last week of the month there was renewed pressure on equity markets from increased anxiety around a possible US/China trade war …|
|+ Many ELS managers are exhibiting notable alpha over equity markets over the year to date.||<> Over the year to date, hedge fund strategies, which carry a negative size bias (i.e. long small caps and short large caps), have performed much better than expected.||<> Japan continued to be a confusing market in March. YTD, the market has been led down by the cheap stocks.|
|+ Corporate Credit managers’ performance was driven by idiosyncratic events in March …||<> Lower-rated high-yields underperformed in sympathy with equities as CCCs (-1.0%) lagged B-rated (-0.6%) and BB-rated (-0.6%) bonds …||<> Performance for outright convertibles were mixed by geography …|
|<> Outflows for HY bond funds continued in March (USD -2.3bn) and marked the sixth consecutive monthly outflow.||- Corporate Credit managers generated flat performance in March.||- Credit markets posted mixed results in March as US and European high-yield were both down, while US leveraged loans and investment grade generated positive returns.|
|<> Emerging Market equities continue to show resilience and have outperformed developed markets so far in 2018. …||- Technology sector woes triggered by the Facebook data scandal also contributed to a late-month selloff in equities …||- Global trade was the top concern for markets in March amid fears US tariffs on Chinese goods could spark a full-blown trade war …|
|<> Analysts and macro managers are focusing increasingly on US trade policy rather than interest rate differentials.||<> The USD showed no signs of sustained strength during recent risk off episodes.||<> Cross currency basis markets are telling us there are plenty of USD around.|
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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