During the month of October, investor sentiment was lifted by two events: the United Kingdom concluding a deal with the EU (hence reducing the risk of no-deal Brexit) and Donald Trump’s Administration being seemingly close to signing a trade deal with China. Although the latter is not expected to be very significant, it is a step in the right direction. Although macroeconomic indicators are still looking weak, forward-looking indicators are improving.
It was a strong month for equity markets in general. Higher beta indices and markets positively correlated to international trade outperformed. The Nasdaq Biotech and the Swedish OMX Stockholm 30 Index were among the best performers, returning +7.73% and +5.22% respectively. Sector-wise, healthcare, information technology, consumer discretionary and industrials outperformed defensives.
Long-term sovereign yields in developed markets slightly increased during the month. The US 10-year Treasuries finished the month at 1.80%, from 1.68%. Within corporate credit, riskier issues outperformed investment grade.
Commodities had, overall, a strong month. Palm oil futures increased slightly more than 17% during the period, rising to a 2-year high. Commodity stock levels published by the Malaysian Palm Oil Board seemed to be below market expectations.
The HFRX Global Hedge Fund EUR declined -0.19% during the month.
According to data compiled by Morgan Stanley Prime Brokerage, October was a decent month for Long Short Equity strategies. On average, their peer group of Global Long Short strategies returned +1.38%. European and Asian Long Short funds outperformed US-focused strategies, benefiting from the improved investor sentiment. Nonetheless, on a year-to-date basis, US Long Short Equity strategies are clearly ahead of their European and Asian peers. According to the same report, 2019 is on track to be one of the best, in terms of alpha generation. During October, the momentum unwind continued. The current negative correlation between momentum and value factors provided a tailwind for value bias managers. Year-to-date, the strategy continues to perform well. The current environment is not easy, due to economic uncertainty and rapid sentiment changes. However, strong dislocations always create opportunities for either long or short investments. This strategy offers a wide range of levers that can be used to benefit from industry restructurings and sector dispersion from a long or a short perspective.
It was a difficult month for Systematic Global Macro strategies, which were affected by the momentum reversal. On average, managers lost money on long fixed income, long US dollars and short energy investments. Performances for discretionary managers were more dispersed. Long positions in Argentinian assets were positive. Also, over the short term, these managers’ greater flexibility helps them adjust their positioning. With developed market rates pointing to the bottom, EM high-yielding assets are starting to become somewhat desirable again. In this environment, we would tend to favour discretionary opportunistic managers that stay on the sidelines awaiting asset price dislocations. These managers can use their analytical skills and experience to generate profits from a few strong opportunities worldwide.
Systematic trend-following strategies continued to suffer during October, losing money on currencies and long fixed income positions. On the other hand, shorter-term statistical arbitrage strategies’ performance was more dispersed. Some strategies benefited from rising volatility levels to post robust performances while staying in the red for the year. The environment remains challenging for statistical arbitrage strategies due to the momentum factor unwind. However, despite the factor reversal, the correlation between momentum, low volatility and quality versus value factors remains at extreme levels. One could expect a continuation of further reversal periods.
Last month, we wrote that the new LTRO programme and the Fed’s dovish tone were likely to sustain the ongoing swap-spread widening. However, central banks had made a clear pause on this dovish rhetoric, which triggered a strong reversal both on the US and the European rate markets. It is worth highlighting the positive convexity of the strategy, which reacted very well to this sudden change in direction, with strong gains being made in US basis trading as well as in the JPY relative value sector.
Emerging Markets is recovering from previous losses and benefiting from improving investor sentiment on a relative value analysis. The big picture still presents high levels of uncertainty, however, in a sluggish growth environment, EM assets remain interesting opportunities for investors hungry for yield. Furthermore, declining US rates have kicked down the road the problem of dollarized debt EM economies. As expected, Alberto Fernandez won the Argentinian elections in October. This will be closely followed as a future indicator of the country and of EM investment attractiveness. It has not been an easy environment for EM strategies. Nevertheless, strong dislocations are generating opportunities for seasoned opportunistic managers.
2019 has been an average year for Event Driven strategies, especially when compared to more directional strategies. Pure merger arbitrage strategies’ performances have been rather muted. Economic and political uncertainty had a negative impact on the volume of announced mergers & acquisitions. Nonetheless, 2019 has had a sustained level of large deals (over $20 billion) which is keeping it on track to be a solid year in terms of deals. We are optimistic about the opportunities for Risk Arbitrage due to a supportive business environment with benign financing conditions, and the willingness of corporate management teams to fight for sources of business growth. Also, spreads for large deals are currently at interesting levels due to the increased complexity of the approval process, specifically in the US. It is also interesting to note that the increase in shareholder activism challenging announced deals is also helping keep spreads wider. Finally, in countries like Japan, some managers have pointed out that corporate governance initiatives have led to several significant cross-shareholder unwinds over the past few months.
The 2019 risk-on environment reversed most of the spread-widenings seen in Q4 2018. Distressed and stressed strategies are currently tending to overweight their portfolios with hard-catalyst investment opportunities, which are diminishing the negative impact of beta. Managers are raising cash levels to keep dry powder, waiting to reload the portfolio with new issues hitting the distressed market. We are closely monitoring distressed managers, due to the potential of high expected returns, but remain broadly on the sidelines.
Despite some more volatility, spreads – supported by the chase for yield – are still heading in the same direction. Hence we remain underweight, as there is limited-to-no comfort in being short the credit market, where there is strong demand and the negative cost of carry is quite expensive.