FRM Viewpoint - September 2018
- The HFRX Global Hedge Fund Index fell -0.69% in September, bringing its YTD return to -1.23%.
- Hedge funds continued to struggle to make much headway with quantitative strategies struggling again with reverting markets.
- September price action in markets was characterised by a significant move upwards in interest rates across developed markets.
- Risk markets ended the month generally positive, supported by strong economic data in the United States.
On the whole in September, hedge funds continued to struggle to make much headway in terms of performance for the year to date, with quantitative strategies, both CTAs and Statistical Arbitrage, struggling again with reverting markets, and mixed performance from Equity, Credit and Macro strategies, and more positive returns from Event strategies.
Discretionary Equity Long-Short managers continued their mixed performance for 2018 in September, with generally better alpha than we have seen for the past few months. There is a sense that valuation discrepancies in equity markets are starting to narrow, although they remain wide relative to historical data. On the whole, September was somewhat reversionary, with managers who produced better performance in August struggling in September and vice versa, largely due to the outperformance of European and Asian markets over US markets through the majority of the month.
Quantitative equity strategies had a more difficult month in September. In keeping with the reversionary theme, Technical Statistical Arbitrage managers had a weak September after a noteworthy month in August. There was clearly a sell-off in the momentum factor in the third week of the month which disappointingly seemed to impact returns. Additionally, the much anticipated triple witching (when quarterly futures, quarterly index options, and quarterly single stock options all rolled on the same day as a GICS sector and MSCI country rebalance) was a non-event for these strategies. More Fundamental managers also had a poor month, with some impact clearly coming from the momentum factor.
The biggest tension in the Event Driven space continues to be focused on the ongoing trade war between the US and China. However, that did not hinder merger deal flow in September. 2018 continues to be on track to be one of the strongest years in recent history for deal activity and there were multiple potential opportunities for managers in this space. Exposures rolled off managers portfolios as deals closed, such as the two year competition for the Broadcaster Sky. Comcast prevailed with the highest offer for the company in a London auction during the month. Comcast outbid 21st Century Fox and Disney bringing the bidding saga to an end.
Other merger transactions progressed, such as two eyewear companies, a chemical company/industrial gasses company, and two food companies. A high conviction view across the sector in a biotechnology company/a pharmaceutical company deal also progressed with regulatory approvals even though there remains some shareholder skepticism over the transaction. Further, a computer company’s pending acquisition of its tracking stock had new developments with reports that the CEO is said to be exploring the possibility of an IPO in lieu of the transaction and news that he plans to delay the investor roadshow.
Leveraged credit markets generally took the higher yields in stride and generated positive total returns with outperformance of lower-rated credit vs. BB-rated HY and investment grade credit markets. Emerging markets credit also stabilised during the month and rallied over the latter weeks of September. By sector, the HY sectors of retail and telecommunications outperformed and remained two of the best performers YTD in the US high yield market.
Corporate Credit managers were broadly positive on the month. Some managers benefitted from additional gains in a number of idiosyncratic positions that have driven performance this year including Puerto Rico (additional progress in discussions between bondholders, the Oversight Board, and the Government), long positions in energy credit and reorg equities (sector strength with the rally in oil prices), and equity stub trades (an investment company discount narrowed further following the tender in August).
Structured Credit spread performance was fairly muted in September as spreads were largely stable. Structured Credit managers’ performance was primarily driven by carry with equity and credit hedges generally a drag on performance but overall performance was generally slightly positive for the month.
September was a poor month for CTAs, giving back most of the gains from a notable August. This was particularly true for those with a shorter average lookback. Rather than a particular asset class, the poor performance was a combination of losses across a large portion of sectors. By asset class, commodities was perhaps the strongest but in aggregate were close to flat. This was driven by gains in the energy sector, offset by large losses in Copper. All other asset classes detracted.
In Equities it was the fastest managers who were most negative, caught by the moves up toward month end in European equities. Japan was the one strongly positive region, where long exposure was positive. In Fixed Income, long positions in Europe (and Germany in particular) offset the gains from short exposure in the US. The reversal of the dollar in the first half of the month hurt managers’ long dollar bias. Alternative market managers fared slightly better, isolated from some of the difficult trades in developed markets. We view the main risk in the strategy remains the net short FX against the dollar, with net equity exposure also creeping up.
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 -0.05% in September and up +2.34% year-to-date …||- US inbound activity is at a 5- year low and China outbound activity is at a 3 year low …||+ Europe is 36% of cross-border volume activity in 2018, nearly 3x historical average …|
|+ Global M&A deal count and volume decreased in September but 2018 is still on track to be one of the best years in recent history.||<> Managers are pulling in risk given the growing macro concerns and focusing on short term catalyst opportunity.||+ Cross boarder M&A is still a dominate feature due to a shift towards creating “Regional Champions” driven by intra-regional activity.|
Equity Long-Short (ELS)
|+ Hedge fund managers generally had a positive month in September helped by beta and idiosyncratic stock performance …||+ Following the sell-off in the first half of October, hedge fund managers are generally being pragmatic and reducing risk …||<> September saw European markets continue to lag US markets for the first few days of the month …|
|- During September smaller cap stocks significantly underperformed their larger cap peers, with a performance discrepancy of around 3% between the S&P 500 and the Russell 2000.||<> While there are a number of hedge fund managers who are long US assets, European assets are trading at cheaper multiples of earnings, and as such represent more of a Value trade on a global scale.||- Over a very long horizon, the Shiller PE on US Equities has only been as high as the value at the end of September twice; in 1928 before the Great Depression and in 1996-1999 before the dot com crash.|
|<> Against a backdrop of rising US Treasury yields, climbing oil prices, and continued lower-than-average issuance, high-yield bond spreads tightened to a 10 year low …||- Preferred equities came under pressure in September largely due to negative technical pressures …||<> Fund flows were mixed in September with outflows returning for HY bond funds (-$1.8bn; JPM) while inflows continued for loan funds (+$0.9bn; ninth consecutive monthly inflow) …|
|<> Corporate Credit managers generated flat to slightly positive returns in September.||+ Lower-rated credits outperformed in September with CCCs (+1.0%; JPM) outperforming BB (+0.6%) and B-rated bonds (+0.3%).||+ Default activity remained low with a single company defaulting on $1.7bn in bonds and loans.|
|+ September price action in markets was characterised by a significant move upwards in interest rates across developed markets on the back of continued strong economic data …||+ EM currencies recovered on the back of capital flow stabilisation and credible monetary policy steps …||<> The sustained move up in crude oil has meaningful impact on macroeconomic equilibrium as it pertains to inflation pressures and the forward path for interest rates …|
|<> Despite escalating trade concerns throughout the month, risk markets ended the month generally positive.||- Emerging markets equities were weaker for the month as rising US rates and higher oil prices created headwinds for emerging Asian markets.||+ Orthodox monetary policy moves by Argentina and Turkey were relevant sign-posts that helped the overall asset class.|
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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