FRM Viewpoint - January 2019
- The HFRX Global Hedge Fund Index was up 2.13% in January.
- Equity and credit markets rallied from December lows with US high yield posting one of its best starts to the year.
- Emerging market assets posted robust returns in the new year supported by the Fed’s plans to pause further rate hikes and an easing of US-China trade tensions.
- Central bank policy and geopolitical developments continue to drive the global macro outlook.
Hedge funds started 2019 with mixed performance. On the whole, anything with positive risk-asset exposure benefited from the bounce in equities and credit, whereas trend following strategies generally were whipsawed from the snap-back after the equity market drawdown in December. The early part of the market rally was also rather indiscriminate, meaning that factor models struggled to add alpha despite a reduction of overall volatility, but alpha-generation generally improved through the latter part of the month despite the market rally softening.
Equity Long-Short returns were generally positive, supported primarily by beta exposure to a rallying market. Many managers had, however, reduced net and gross exposure in the fourth quarter, and as such participated less in the market bounce than they would have hoped. After the initial bounce, returns to alpha started to strengthen through the month, which may suggest that managers were redeploying risk from the lower levels seen towards the end of December.
Returns to Market Neutral strategies in Asia (and in particular Japan) seem to have been the best performers during the month from an alpha perspective. In the more quantitative equity strategies, the picture is more mixed. Fundamental strategies performed positively, generally helped by a return to the Value factor, whereas more Technical strategies struggled to add value.
Equity managers are increasingly bearish for the outlook on earnings in 2019 and feel that while the rally has given managers the opportunity to increase gross exposure levels, there is less enthusiasm to increase net exposure until a clearer macroeconomic picture emerges. In particular, managers are trying to avoid thematic bets in favor of stock-specific opportunities within sectors.
January also saw a rebound in the credit markets alongside other risk assets with US high yield posting one of its best starts to the year. Leveraged loans also improved in January despite outflows continuing, albeit at a slower pace compared to December. Improved market sentiment resulted in a pickup in high yield primary market activity after no US high yield issuance in December. Performance in US high yield was noteworthy across the rating spectrum with all sectors posting positive returns for the month. Energy and Healthcare were among the best performers.
Corporate Credit managers largely performed positively in January with Distressed managers outperforming, driven by a notable upward repricing of several reorg equities that had seen steep sell-offs in the previous few months. GSE preferreds and Puerto Rico muni bonds were also positive contributors for several managers on ongoing favorable news flow. US financial preferreds, after suffering markdowns over the previous few months, also saw a robust month.
Performance was mixed in Structured Credit with relatively stable pricing across most sectors, which lagged the rally in corporate credit. Carry and some mark-to-market gains were offset by corporate credit and equity hedges, which had helped in the previous few months.
In Merger Arbitrage, portfolio risk was lower during the month as mergers completed at year end and managers await recycling capital into new merger transactions. During the month of January, a pharmaceutical company completed its acquisition of a biotechnology company and rolled out of managers’ portfolios. While the US Government shut down caused delays in regulatory approvals of merger deals and other corporate events, global M&A volume picked up from the December’s declining volume. Softer catalyst Event strategies are generally net long equities, and as such benefited from the rising equity markets during the month.
Managed Futures managers suffered another disappointing month, with losses driven by snap-backs in Equities, Commodities and FX. The equity loss is the easiest understood, as markets had been trending downwards for much of the fourth quarter, leading to positioning being materially net short coming into 2019 and losing money into the rally. Oil followed a similar trajectory, also leading to losses. Managers tend to use a covariance matrix to avoid duplicating exposures, and as such the losses in equities were perhaps smaller than might have been expected given the shape of the market, but Oil losses more than offset any benefit from smaller equity positioning. The losses in FX were led by the euro weakness versus the dollar.
Discretionary Macro managers had a mixed month, with mean reversion trades working better than trend following strategies. Fixed Income markets were generally range-bound and failed to contribute meaningfully to return, whereas FX and Commodity strategies were more significant contributors.
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 3.52% during the month of January…||<> With noteworthy deal activity in January, managers added portfolio risk to new pending mergers …||- Managers continue to rotate exposure to US merger opportunities as activity in Europe has slowed in recent months …|
|- European deal flow continued to decline. North American dead flow led the activity followed by Asia.||<> Managers expect bouts of volatility to provide potential opportunities to enter in spreads at more attractive levels in upcoming months.||+ Merger Arbitrage continued to perform positively as pending mergers progressed and new deals were announced.|
Equity Long-Short (ELS)
|+ ELS mangers had a more positive January with returns helped by the equity market recovery and the outperformance of small caps over large caps …||<> Managers remain focused on the alpha opportunity from valuation discrepancies within markets that generally widened during 2018 …||- Hedge fund managers are increasingly uncertain as to the future direction of equity markets …|
|- Managers that enacted risk controls in the middle of the equity market sell-off missed out on some of the recovery during January.||<> Gains came from the outperformance of Small Cap stocks over Large Caps, while in Japan the market was led higher by Value stocks.||+ Most managers reported that alpha was easier to come by as market participants redeployed risk, better facilitating price discovery.|
|<> Fund flows were mixed in January with US HY funds reporting inflows of $bn while loan funds continued to see outflows (-$3.7bn) …||+ Broad corporate credit market spreads have widened in recent months, opening up the potential for better opportunity sets in the coming months if sustained …||- Single-name credit shorts and market hedges as well as some idiosyncratic names were detractors in January …|
|+ Global credit markets participated in the January risk-on rally across asset classes triggered by dovish Fed commentary and process in US-China trade talks.||- Structured credit spreads across most sectors have widened in recent months but potential risks remain from higher rates and economic surprises||<> US HY, leveraged loans, and IG markets were up 4.6%, 2.4% and 2.1%, respectively, while European credit markets lagged but still posted solid returns (EU HY +2.2%)|
|+ Global equity markets posted their best returns in over seven years amidst healthy corporate earnings results, Fed plans to pause further rate hikes, and more favourable US-China trade talks…||+ A more positive sentiment around Brexit developments drove the reversal of the pound sterling’s downward trend …||- Equity volatility indices declined meaningfully both in the US and globally from peak levels reached in December…|
|<> A rally in EM equities and fixed income extended to rallies in local and hard currency-denominated debt.||- Macro managers are navigating market movements carefully with mean reversion trades recently working better than trend following strategies.||<> Investor fears relaxed notably this month, largely driven by more dovish sentiment from central banks and increased stimulus in China.|
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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