FRM Viewpoint - May 2018
- The HFRX Global Hedge Fund Index rose +0.26% in May, bringing its YTD return to -0.66%.
- Geopolitical risks continued to unnerve investors and drive dispersion between regional markets in May.
- Hedge funds generally produced a positive return during May, with the best returns coming in the first half of the month.
Hedge funds generally produced a positive return during May, with the best returns coming in the first half of the month (where all strategies performed positively) and a more mixed second half of the month. The best performing strategies were in the Relative Value complex, where some managers were able to trade both the mean reversion of risk spreads in the first half of the month and the pick-up in volatility during the second half of the month.
Equity Long-Short strategies enjoyed a positive month for most of May, but gave back some of their gains on increased market turbulence during the last few days of the month around concerns on the sell-off in Italian government debt. Regional performance was mixed, with noteworthy returns to single stock momentum in Europe and Asia for most of the month (albeit curtailed towards the end of the month), whereas returns from US managers were driven more by valuation.
May was a positive month for the majority of Statistical Arbitrage managers. After a tough period for performance, one of the most notable areas was in Asia-centric fundamental strategies; China, Japan and Korea all appeared to perform positively for factor based models. In other regions, performance was more muted, with European strategies roughly flat, and US strategies detracting. Technical strategies also had a positive month, but as ever had some divergence in performance. Diversifying and Futures strategies were typically detractors, with those managers trading Futures hurt alongside managed futures, and shorter term FX strategies also detracting.
Event Driven strategies also rebounded in May driven by merger spreads tightening and notably a rebound in the stock of a global semiconductor manufacturer due to increased optimism for deal approval by Chinese regulators. In addition, spreads for vertical mergers also performed positively following the completion of the cable television company/telecommunications company trial as the market viewed the trial developments as indicating a higher probability the Judge would rule in favour of the companies. This led to tightening spreads for mergers such as an insurance company/retail pharmacy company and two mass media companies.
Given this backdrop, most Event managers performed positively in May, particularly those with larger merger arbitrage allocations. Global deal activity increased month-over-month with over USD 340bn of announced mergers (Source: Bloomberg, as of 30.5.2018).
Credit underperformed equities in May. Returns were modest for US high yield and loans and the markets traded in a relatively tight range with light secondary market activity. The European high yield market was soft with Retail and Transportation leading on the way down. Within US high yield, sector performance was mixed with no meaningful outliers. Energy and Healthcare names mostly performed positively while performance was mixed in the Retail sector, driven by earnings (which were a mixed bag). US high yield issuance remained below historical averages and there continued to be outflows from high yield funds and inflows into loan funds. It was another month of outperformance for lower-rated credits resulting in the spread between CCCs and BBs compressing towards historical tights.
Corporate Credit managers generally posted positive returns in the month helped by gains in financials, several stressed and distressed commodity credits, gaming and media reorg equities, and Puerto Rico muni bonds. Single-name credit shorts and market hedges were detractors. Most securitised products sectors saw tightening in May helping support the positive performance for Structured Credit managers.
May was a negative month for CTAs on the whole, with all major asset classes detracting from performance, but returns for individual managers were more dispersed than usual throughout the month. For the first half of the month, performance had held up, with long exposure to equities the primary positive driver of returns. However, in the final few days of the month, both crude oil, then equity markets suffered a sharp sell-off around Italian political instability, and both ended up detracting from performance. That period seemed to hit exposure across asset classes, with the short US, long European bond position also detracting in a flight to quality style move. Performance in FX was much more varied by manager, and seemed to be dependent on positioning in the Euro and CAD.
Discretionary Macro managers experienced more mixed, but generally positive performance, on higher levels of volatility across asset classes, in particular in FX, Fixed Income and Commodities. Perhaps unsurprisingly, long volatility strategies and mean reversion strategies were generally positive, but more directional strategies also managed to finish the month flat to positive despite giving back gains in the second half 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|
<> Indices of Technology stocks in most developed markets returned to near new highs, once again proving to be one of the most resilient sectors against short term dips …
|Alternative risk premia||Trade examples1||Environmental factors|
Relative Value (RV)
|+ The HFRI Event Driven Index was up +1.7% in May bringing YTD returns to +2.2%. …||<> Risk arbitrage spreads were generally tighter in May …||+ Global M&A announcements were up 77% YOY making it the most active May in a decade in terms of volume (GS) …|
|+ It was a noteworthy month for event driven strategies as larger, widely held deals performed positively and equity relative value positions generated positive returns as discounts/spreads narrowed.||- A handful of managers had losses in select equity relative value trades.||+ Cross-border deal activity has also remained elevated, with 42% of global volume in May attributable to cross-border deals.|
Equity Long-Short (ELS)
|- May was generally a positive month for ELS strategies as momentum and small-cap risk factors both experienced gains, as did equity markets in general in the US and Asia …||- Indices of Technology stocks in most developed markets returned to near new highs, once again proving to be one of the most resilient sectors against short term dips …||- European stocks suffered through the last 10 days of the month as concerns over political friction in Italy and Spain once again raised spectres of the Eurozone government debt problems …|
|+ In keeping with the momentum characteristics of the Tech sector, small-cap stocks also generally outperformed their larger peers in May.||- Asian tech stocks also continued to rally through May, generating notable returns from ELS funds in the region.||<> Stocks continue to rally into end-of-cycle dynamics.|
|+ Broad credit market spreads have remained well anchored despite the uptick in equity market volatility as such limiting the availability of stressed/distressed credits …||<> US HY was wider in May as treasuries rallied but the price decline was offset by income resulting in a flat month (JPM; YTD -0.2%) …||- US HY new issuance declined for another month with only USD 16.5bn of primary market activity in May.…|
|+ Structured Credit managers were positive with returns driven by carry as well as few idiosyncratic positions.||+ Corporate Credit managers posted positive returns in May with gains in stressed/distressed, cap structure arb, and reorg./value equities.||- Default activity was fairly muted for another month with only one default on USD 375m of bonds in May.|
|+ We believe the outlook for Global Macro strategies shows promise of an improved opportunity set in the context of higher interest rates, volatility expansion across asset classes and global dispersion …||<> While implied volatility in equity markets stabilised and moved back down since the February spike (VIX index), other asset classes started to reprice …||- The prospect of a strengthened Euro-critical alliance vote saw fears of a Euro break-up resurface …|
|<> Geopolitical risks continued to unnerve investors and drive dispersion between regional markets in May.||+ The yield on two-year Italian bonds rallied over 300bps while the 10-year yield saw its largest single day move since 1992.||<> EM currencies were at the epicentre of pressure from the recent USD strength.|
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.