15 DEC

2017

Absolute Return , Topics

US tax reform causes sharp momentum reversal

One year has passed since Donald Trump was elected to the White House. Subsequently, apart from retreating from several major international treaties, the president’s Administration has been committed to bringing home a victory with the approval of the tax-regime reform. November was close to seeing an agreement on the Republican side. This seems to have triggered a very strong rotation out of technology stocks, which have a lower average tax rate, into financials, which will be among those to benefit the most from the reform.   

Despite the rotation, US equities reached all-time highs, returning +2.81% for the S&P 500. The Rest of the World market index returns were more random. European equities declined on political instabilities linked to Brexit and to the formation of a German governing coalition. Chinese stocks were affected by liquidity constraints on the financial sector. Hong Kong and Japan were among those following the S&P up. Sovereign rates remained overall rather static, apart from the treasuries front-end curve, which was slightly up.

The US dollar lost ground across the board to other major currencies, finishing the month at 1.19 versus the Euro. As for commodities, palladium continued its upward trend, gaining +4.41%, and iron ore’s price was up close to 15% after China’s imports surged strongly in October.     

The HFRX Global Hedge Fund EUR index was down -0.13%.

 

Long short equity

A mixed-bag performance for the long/short equity bucket in November. The strong sector rotation out of technology into financial stocks had an important impact on performance, mainly for managers that were long technology growth and short value styles. The high level of short stock covering also had a negative effect on market-neutral strategies. Despite that, performances were dispersed, since some managers were able to generate alpha on their long and short books from good stock-picking. Considering the rich market valuations, volatility levels will probably increase in 2018. Nevertheless, there are interesting thematics to be explored within the long/short equity space. The probable agreement on a new tax regime in the US will generate opportunities within highly taxed companies. Japanese corporate governance seems to be becoming more sensible to shareholder returns, offering good opportunities on the long side. On the short side, Chinese liquidity restrictions and the financial monitoring of leverage will, for sure, put many highly indebted companies under the spotlight. Also, a lot of European managers remain convinced that the current economic robustness, the European equity underweight in portfolios and its relative cheapness versus other assets make it a very compelling investment opportunity for the quarters to come. Managers are expressing this by increasing their net exposures to European cyclicals at the expense of defensive stocks, considered to be priced for perfection. We think that long/short equity strategies still have many opportunities to offer in 2018.


Global Macro 

Global macro managers did not do well this month. Some funds had strong performance drags, without having any major positive driver to offset the negative contributions. Developed market rates did not move that much during the month and exposures to the dollar were mainly neutral. Turkey’s instability has weighed on the performance of those holding long positions. Equity directional trades have mainly been a losing bet this month due to market reversals. Over the year, global macro managers’ performance has been dispersed. The current transition phase of central bank support programmes has made fund positioning very heterogeneous. We believe that the significant shifts in asset prices will continue to occur as anticipations adjust to reality. Macro strategies will be able to capture and benefit from these wide market moves thanks to increasing volatility on rates and FX.


Quant strategies 

Since the beginning of the year, quant strategies have posted decent returns. After a challenging first half of the year, systematic funds posted a positive performance in H2, with YTD figures in the mid-to-high single-digit range. Longer-term models remain less affected by recent short-term reversals and volatility spikes and, up until now, have outperformed the shorter-term model. Apart from during sporadic events, like the North Korean tensions with the United States during the summer, volatility indices in the US and in Europe remain close to all-time lows while the equity market – driven by a very dynamic TMT sector – keeps rising. Short volatility remains a positive strategy but, overall, higher volatility would increase the number of opportunities in our quantitative bucket, in particular for quant equity market-neutral models.

 

Fixed Income Arbitrage

We kept our fixed income arbitrage allocation at the same level. Despite increasing rethoric from central banks that should ultimately lead to higher rates, volatility remains subdued. Access to balance-sheet lines in the US hasn’t been a problem in recent months as opportunities have shrunk. However, we remain confident on the strategy, as Europe and Japan still offer compelling opportunities, and we look forward to the December expiry. YTD, all managers in that space delivered strong risk-adjusted returns while being positively exposed to volatility.


Emerging markets 

Year-to-date, our EM macro managers have been successful in generating returns in Asia and Latin America. There have been liquidity events in Puerto Rico and Venezuela and several situations of political instability in the Middle East. However, these crises remain, for the moment, contained locally. Emerging markets still offer plenty of investment opportunities across asset classes (currency, interest-rate curve, single-name equity and debt).

 

Risk arbitrage – Event-driven

This year started with great expectations of the strategy following Donald Trump’s pocketful of promises: more industry deregulation, less government interference in corporate America’s ambitions, the possibility of repatriating cash overseas at a friendly rate which could be deployed, among other things, in acquisitions. Even Europe, which tends to be more conservative, was giving out signals of increasing apetite for cross-country consolidation to create European  champions or – following strong currency depreciations – to benefit from good opportunities. Fast-forwarding to the end of 2017, things have not played out as expected. The political noise coming from Washington brought many uncertainties, leading corporates to stay on the sidelines waiting for more clarity. We remain convinced that there are many opportunities to take advantage of in 2018. The new US tax regime is closer to becoming a reality, traditional business models are pushing for further consolidation to face tech giants, the new Franco-German entente seems in line to push ahead for the creation of stronger companies and, finally, China still looks eager to snap up good businesses abroad to assert their status as an economic powerhouse. We remain mindful of the risks linked to the net long bias of event managers. Even though there is increased optimism, the details are still clouded in uncertainty. In M&A strategies, we favour less static and more spread-trading-oriented managers.


Distressed 

This economic cycle continues to push its end-date further down the road. Nevertheless, we are monitoring this strategy closely because of the potential increase in interest rates and the reduction in QE. So far, the energy sector, in which there has been massive issuance in recent years, has provided an attractive pool of opportunities, given the volatility of oil prices and its impact on these securities. Traditional brick-and-mortar retailers, seriously affected by technology innovations, offer plenty of dislocations within the sector. Also, we are seeing that the market is less forgiving, with highly levered businesses severely punishing companies that do not deliver on their promises, as was the case with Altice in Q4 2017.


Long short credit & High yield 

Although the quest for yield and the zero-to-negative rate environment are still providing strong support for the asset class, volatility could spike if rapid changes in monetary policy surprise the market.