FRM Viewpoint - March 2019
- The HFRX Global Hedge Fund Index was down -0.17% in March.
- Hedge fund performance was generally positive with trend-following strategies enjoying a notable month.
- Alpha generation within markets was more difficult to come by than in previous months.
- Treasury 10-year yields declined to their lowest level since December 2017.
March was generally a positive month for hedge fund performance, but characterised by significant variation in individual managers’ returns. Trend-following strategies enjoyed a notable month, and some Relative Value strategies did well against a more muted backdrop. Credit and Equity Long-Short managers had mixed months, with pockets of difficulty in both strategies.
It was a positive month for Trend Following strategies such as CTAs, with only one story worth mentioning – the performance was driven almost entirely by long bond positions. The US was the largest contributor, but Germany was also noteworthy thanks to the sharp drop in bond yields in reaction to the Manufacturing PMI print in the middle of the month. Positions remain sizeable in bonds, but several managers have actually started to reduce the overall exposure toward month end. Elsewhere, FX was generally positive, but varied through the month. The dominant exposure is short FX against the dollar, with short Euro one of the largest positions. Equity was close to flat, and while it moved around through the month, it was never a material contributor in either direction. Commodities were a detractor, largely due to the fall in crude oil.
Other Macro strategies followed a similar pattern. Those with long bond exposure generated the most notable returns, although few of the Discretionary community had the risk tolerance to take such large long bond exposures as their Systematic counterparts. Return contributions from other asset classes were generally muted, although there was significant variation in FX trading strategies depending on region and FX pairs traded.
For Equity Long-Short managers, March was a curious month. The more dovish tone from central banks was seen as a positive sign for some sectors, leading to significant short covering. This short covering has largely supported equity markets through the month, despite the weakening growth outlook in Developed Markets and rally in government bonds. This meant that alpha generation within markets was more difficult to come by than in previous months. We have seen before that a reduction in the long bond yield is typically unhelpful for closing valuation discrepancies within equity markets (since higher bond yields can be a catalyst for more rational pricing under most discount models), and March was no different. Similarly, managers with a small/mid-cap bias struggled during the month.
It was a muted and mixed finish to the quarter for the credit markets after two strong months. The rally in US treasuries resulted in positive returns for the investment grade market. Performance in US high yield and leveraged loans was mixed, with the higher-rated parts of the former outperforming in March. It was a good month for primary issuance in the US high yield market while leveraged loan new issuance lagged given the receding focus on rate risks. Loan funds also continued to see heavy outflows while there were inflows into US high yield bond funds.
March returns for corporate and structured credit managers were modest and largely positive with a few outliers. Unlike February, there were few meaningful idiosyncratic return drivers. Carry was once again the dominant performance driver across securitised products sectors, with secondary market spreads largely stable to modestly tighter across most sectors.
The Relative Value landscape was generally more muted than previous months across all strategies. In Event strategies, median merger spreads had reached fairly tight levels following the completion of a number of larger deals earlier in the year, leading to quieter returns from Merger Arbitrage strategies in March. Other types of Event Arbitrage, such as softer catalyst and Relative Value trades were generally positive in March.
Statistical Arbitrage returns averaged around flat, but unlike other strategies, they saw relatively little dispersion between managers and sub-strategies. The lack of obvious factor support (such as strong return to Value or Quality) meant that Fundamental strategies were largely treading-water for the month, whereas the more Technical strategies struggled with relatively benign levels of equity market volatility. Simpler forms of Statistical Arbitrage, such as those seen in Alternative Risk Premia programs also had a mixed month. The shift in the yield curve meant that lower beta, higher dividend stocks tended to outperform, leading to positive returns for Low Beta and Low Volatility programs, and negative returns from Small Cap vs Large Cap strategies. Value and Quality factors as stand-alone programs also struggled during the month.
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 -0.04% for the month bringing year to date performance to +4.25% …||+ Tactical managers who take profits and re-enter exposures after bouts of volatility continue to outperform peers who take a more long term approach …||- Cross-border M&A activity has declined 30% versus 2018 …|
|- Ongoing trade negotiations between the US and China as well as Brexit uncertainty has hampered corporate action.||- Hang Seng A/H share class arbitrage suffered due to significant intermonth volatility.||+ While deal count continues on its multi-month downtrend, risk levels are in line with historical averages and soft catalyst event opportunities continue to be plentiful.|
Equity Long-Short (ELS)
|+ Equity Long-Short managers sustained gains throughout March, benefitting from the softer tone from Central Banks and meaningful short covering over the month …||- Quality stocks are becoming more expensive as they continue to beat value stocks in the backdrop of more cautious growth and inflation expectations …||+ The US Equity market concluded its best quarter since 2009 while global equity markets experienced their largest quarterly gains since 2010…|
|- While global equity markets posted their best quarterly gain in seven years, investors pulled $79bn from equity funds.||+ The post-Fed rally helped push the technology sector’s ratio versus the broader market to an 18-year high (S&P 500 IT Index/S&P 500 Index).||- Alpha generation proved more difficult in March amidst a weakening growth outlook in Developed Markets and a rally in government bonds.|
|<> Fund flows were mixed with US HY funds reporting inflows of $1.9bn while loan funds continued to see outflows of $2.3bn…||+ Gross HY and leveraged loan new issuance increased month-over-month in March. HY primary market activity and loan issuance were also up…||- Structured credit loss-adjusted portfolio yields still look reasonable but potential risks remain from higher rates and economic surprises …|
|+ Global credit markets were mostly positive in March with the exception of US leveraged loans.||- There were five defaults (vs. three in February) totaling $2.5bn (down from $6.5bn) of bonds and loans in the month.||<> Broad corporate credit market spreads have widened over the past two quarters after trading close to post-crisis tights.|
|+ Fixed income markets rallied sharply in March driven by weaker European data, softer inflation, and a more dovish tone from global central banks …||+ Despite US economic data showing widespread weakness, the US Dollar was marginally stronger for the month…||+ More accommodative policies from the Fed, CB, and BOJ and developments in US/China trade talks drive the macro opportunity set…|
|- Emerging Markets FX was negatively impacted by country-specific stories that led to currency weakness throughout the month.||- Treasury 10-year yields declined to their lowest level since December 2017 and rates on benchmark German bunds sank further below zero.||- Managers found the uptick in FX and interest rate volatility difficult to monetize as volatility remains stubbornly low relative to historical levels..|
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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