FRM Viewpoint - October 2017
- The HFRX Global Hedge Fund Index rose +0.69% in October, increasing its YTD return to +5.14%.
- Hedge funds generally demonstrated positive performance across all strategies in October, as slightly higher volatility in Equities and Bonds helped the price-discovery process.
- October saw an extension of the rally in risk assets, driven by strong economic fundamentals, improving corporate earnings, and dovish central bank rhetoric.
Hedge funds generally demonstrated positive performance across all strategies in October, as slightly higher volatility in Equities and Bonds helped the price-discovery process, and low correlation between assets and asset classes meant that managers could take more risk exposure to the benign environment.
Equity Long-Short saw gains during the month, helped by rising Equity markets and a positive reaction to the start of the Q3 earnings season. In general, earnings beats and misses matched hedge fund managers’ views on corporate health, and stock prices reacted rationally to the news. European managers generally outperformed their US counterparts. One area of weaker performance was low-net Japanese managers, who commented that the strength of the index rally was largely indiscriminating between better and worse companies and therefore not a good environment for generating alpha.
Corporate Credit managers mostly posted modest positive returns in the month, driven by small idiosyncratic P&L drivers with Puerto Rico being one of the largest detractors for managers with that exposure. The Puerto Rico municipal Bond sector continued to see heavy markdowns across the complex as investors assess the near- and long-term impacts from Hurricane Maria on the economy and recovery prospects for the debt. Puerto Rico general obligation Bonds are down by more than 50% in less than two months in a sign of potential capitulation by mutual fund and hedge fund holders alike.
Also in Credit, Caesars’ long-awaited bankruptcy emergence happened in October but it was mostly a non-event in terms of P&L contribution given the already notable YTD performance. Credit and reorg-Equity longs generally performed positively given the supportive markets. Structured Credit manager performance was also positive but muted in October, driven mostly by principal and interest income.
It was a positive month overall for Global Macro managers. Fixed Income remains the biggest area of risk, particularly shorts in US rates, so the sustained selloff in Developed Markets Fixed Income contributed to gains. Interest rate volatility rose during the month and monetary policy divergence extended from the Developed Markets vs Emerging Markets arena into G4, as the ECB announced a more cautious taper of QE against a backdrop of more hawkish G4 central bank rhetoric. Relative Value Fixed Income strategies generally benefited from this dynamic as well, with managers short US and UK rates and long Brazil and Emerging Market Fixed Income.
Bullish sentiment within the Commodity complex continues to grow, particularly in crude oil and industrial metals, along with some protective views on gold. Theses around this range from increased electrical power and nickel use, to the rising importance of non-fiat currencies, to persistent Emerging Market Commodity demand. Overall, these contributed to gains for Global Macro managers on the month.
Active trading in China markets has been a noteworthy driver of P&L for many Emerging Markets focused managers. Since the People's Bank of China’s relaxation of the reserve requirement on FX derivatives in early September, the RMB has reversed nearly 3% from the YTD highs, though long positions in CNH/USD are currently still favoured given the positive carry profile. This month’s 18th National Party Congress saw a consolidation of power by President Xi, and potentially paves the way for further rebalancing and market liberalisation. We believe the growth and opening up of China’s Fixed Income markets to be a potential area for trading opportunity.
For Managed Futures managers, Equity has generally been the main driver of performance as net exposure to the asset class remains long and Equities rallied across the globe during October. Additionally, Commodities also contributed positively for some managers, thanks to long positions in industrial metals, while Fixed Income trading was largely flat. FX detracted marginally from some managers’ returns thanks to the net short USD position.
In Event strategies, deal activity was quiet in October; only USD 280bn of confirmed deals were announced during the month; the lowest number that we have seen in a while. The only notable announcement was Hochtief’s counterbid for Abertis (topping Atlantia’s offer). Abertis rallied ~+8% on the news.
It was a favourable month for Relative Value strategies in general. The first week of October was particularly beneficial for arbitrage strategies around ETFs. As flows slowed it allowed the market to consolidate any over or under valued legs of common Relative Value trades. Risk arbitrage in existing M&A deals was positive as well, as deal spreads generally tightened.
Statistical Arbitrage saw another positive month in October. After a setback in September, fundamental strategies once again led performance across regions. It was a notable month for price momentum-based signals, while valuation-based metrics had a more difficult time. Futures strategies were positive, as one might expect given the robust month for Managed Futures. The more technical and faster strategies lagged the trend-following indices, but were still a positive contributor to Statistical Arbitrage as a whole.
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)
|<> Factors experienced diverse performance in October. Price Momentum and Earnings performed well while Value and Quality did poorly ...||- Abertis was a positive outlier in October, as a counterbid from a consortium finally materialised …||+ Slowing of ETF flows allowed the market to consolidate any over or under valued legs of common Relative Value trades …|
|- October continued to be a slightly challenging environment for mean reversion focused models.||<> A couple of deals in the US widened slightly during the month as they wait on approval.||<> Deal activity remained muted in October. Only USD 280bn of deals were announced during the month.|
Equity Long-Short (ELS)
|+ Managers are reporting that stocks are now performing more in line with their fundamental strength or weakness ...||- So far, those looking to short the high valuations in the Technology sector have been hurt …||+ Synchronised global economic growth and improving corporate earnings drove risk assets higher during the month …|
|<> European managers generally outperformed their US counterparts.||+ The well-documented strength in Technology companies continued in October.||<> Managers continue to be concerned about markets making new highs and the potential for a correction.|
|<> Corporate Credit managers were generally flat to positive in October, driven by modest idiosyncratic P&L drivers ...||- The Puerto Rico municipal Bond sector continued to see heavy markdowns across the complex …||+ Global Credit markets were broadly positive in October (US HY +0.44%, loans +0.67%, EU HY +1.08%; JPM) …|
|<> Structured Credit manager performance was positive but muted in October.||<> Ceasars’ long-awaited bankruptcy emergence happened in October, but it was mostly a non-event in terms of P&L contribution.||+ US HY was, in part, supported by inflows, slower new issuance and optimism about US tax reform.|
|+ Most Developed Market rates rallied in October, with the exception of the US ...||+ The USD continued its upward trend in October, outperforming all other G10 currencies …||+ October saw an extension of the rally in risk assets, driven by robust economic fundamentals, improving corporate earnings, and dovish central bank rhetoric …|
|<> Price Momentum and Earnings did well in the US and Emerging Markets ex Asia but they performed negatively in Asia ex Japan.||- Uncertainty surrounding Theresa May’s leadership position and ongoing Brexit negotiations contributed to GBP weakness.||<> Divergence in G4 rates in October is representative of a broader monetary policy divergence within global Fixed Income 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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