FRM Viewpoint - February 2019
- The HFRX Global Hedge Fund Index was up 0.63% in February.
- Hedge funds posted gains once again in February to continue the positive start to the year.
- Global risk assets posted strong results amidst receding concerns of a global recession.
Hedge Funds posted gains once again in February to continue the positive start to the year. As with January, this was bolstered by those strategies that carry risk asset exposure (notably in the longer biased equity, and credit mangers). However, unlike January, this month risk asset beta was accompanied by a healthy run from trend following strategies. Within the equity market, there was alpha available to market neutral stock selection strategies in the first half of the month, before drying up in the second half.
Equity Long-Short managers had a positive month in February, helped by: the continued tailwinds from January; higher equity markets; falling volatility; broad outperformance of Small Caps over Large Caps; and an expansion of the aggregate gross book across the industry following heavy deleveraging in Q4. As we alluded to above, the earnings season has generally been quite mixed from a corporate perspective, with a softening of earnings expectations across the board, but more signs of shareholder friendly behavior (such as share buybacks) to help temper the weaker news. Stocks continue to react significantly post earnings announcement, but managers are reporting more rational pricing – i.e. stocks that beat earnings estimates are rallying and holding onto gains. Managers remain cautious on the overall outlook for equity markets, and have generally increased gross exposure more than net, although there has been a small increase in beta across the Equity Long-Short universe.
Statistical Arbitrage managers were able to generate positive returns in the first half of the month, and most held onto this rather than improving upon in the second half of the month. This was predominantly from technical models rather than fundamental strategies, with broker models suggesting negative performance from basic factor models.
Similar to equities, credit markets continued to build on January gains. US high yield and leveraged loans as well as the European high yield market posted another noteworthy month in February. In US high yield markets, there were once again positive returns across the rating spectrum with most sectors up in the month. Though on the mend, gross US high yield and leveraged loan issuance remains meaningfully lower year-over-year given the slow start to 2019. However, net new issuance is now in line with last year. Fund flows remained mixed in February with high yield funds enjoying inflows while outflows continued from loan funds.
Against this backdrop, corporate credit managers were largely positive in February with a number of idiosyncratic P&L drivers including the late-January bankruptcy filing of a gas and power company, where we expect managers to be increasingly involved over the coming months. The completion of the Puerto Rico COFINA restructuring and the announcement of the largest bank merger in a decade (with positive impact on bank capital securities) were other notable drivers during the month.
In the structured credit world, spreads across most securitized products sectors were also tighter in February, but lagged the significant rally in corporate credit. Credit risk transfer and CMBS sectors outperformed. Returns for Structured Credit managers were driven largely by principal and interest income, with corporate credit and equity hedges offsetting the modest mark-to-market gains.
Event driven managers broadly generated positive returns. Most continue to ramp up portfolio exposures as deal activity remains robust in the US and the regulatory backlog from the US shutdown continues to clear. European activity continued to be weighed down by Brexit uncertainty. The main driver of performance was the soft catalyst event books, which continue to perform positively on the back of equity market strength.
For Macro managers, performance was generally muted over the month. As we have mentioned, both the yield curve and the USD were relatively stable (indeed the MOVE index is now back close to all-time lows), and equity up is not necessarily an environment all that conducive for macro strategies. The most relevant topics for managers continue to be the Fed rhetoric; continued improvement in US-China trade negotiations; and the policy rate divergence between developed and emerging economies – most EM countries have been easing (Brazil, India, China, and Russia), Mexico is the exception. Many have also commented on the new record amount of sovereign bonds with negative yields (USD7.3 trillion).
While discretionary macro was generally down, February was mostly a positive month for trend following managers. By asset class, Equity and FX were generally positive, while Fixed Income and Commodity trading were flat. In equities, long positions were broadly positive as major indices drove higher throughout the month. Most managers switched their US equity exposure from short to long at some point between mid-January and early February, and benefitted from the continued rally in the equity market. In FX, most managers were positive as short JPY, EUR and AUD exposures made gains. In Fixed Income, long positions in Australia, Germany, and the UK were positive while long positions in the US detracted. Commodity exposures were more varied across managers, however in aggregate, positions in Energies detracted and short positions in wheat and coffee contributed.
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 1.5% in February and +4.8% year-to-date …||<> Merger arbitrage had mixed performance as some high conviction mergers progressed smoothly …||- European M&A has moderated due to ongoing negotiations around Brexit …|
|<> Managers continue to rotate exposure to US merger opportunities as European opportunities have slowed in recent months.||+ Special situations and relative value trading experienced gains as the backdrop behind spinoffs and other corporate events improves.||- Global M&A deal flow continues to be inconsistent as management teams react to the dynamic macro backdrop.|
Equity Long-Short (ELS)
|+ Equity Long-Short managers sustained gains throughout February, generally benefiting from a continued rally across global equity markets …||<> Returns were helped by higher equity markets, subsiding volatility, broad outperformance of Small Caps over Large Caps …||- Hedge fund managers remain cautious on the overall outlook for equity markets …|
|+ Many managers view this outpacing trend as evidence of mounting escape velocity.||+ The outperformance of Small Cap stocks over Large Caps persisted, which served as a source of stronger hedge fund performance in February.||<> From an alpha perspective, managers remain focused on potential opportunities from valuation discrepancies within markets that generally widened during 2018.|
|<> Fund flows were mixed with US HY funds reporting inflows of $4.8bn while loan funds continued to see outflows of $1.8bn…||+ US HY returns were positive across the rating spectrum with CCCs modestly outperforming BBs and all 21 JPM US HY industry groups up for the month …||- Structured credit spreads across most sectors have widened recently but potential risks remain from higher rates and economic surprises that upset the status quo …|
|+ Global credit markets gained on receding macro risks, dovish central bank commentary, and improving primary markets.||- Default activity in February (2 defaults totalling $5bn in bonds and loans) was the highest since March 2018.||<> Broad corporate credit market spreads have widened in recent months after trading close to post-crisis tights.|
|+ Macro managers are navigating market movements carefully with specific focus on global monetary policy divergence, developments in US-China trade discussions, and Fed rhetoric overall …||+ Sterling strength was specifically boosted by May’s decision to permit Parliament to vote on seeking an extension of Article 50 …||- Global risk assets posted positive results amidst receding concerns of a global recession …|
|<> The overall environment of a fairly stable yield curve and USD was not the most conducive for macro strategies to post outsized gains.||- Latin American markets paired back gains seen earlier in the year with particular weakness out of Brazil amidst uncertainty around pension reform and slowing economic growth.||<> Fed messaging over the month was additionally supportive given its shift to a more accommodative approach in raising rates.|
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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