24 SEP

2018

Absolute Return , Topics

Wall Street: There is a light that never goes out

The market always needs a good story to buck it up. Fears of a full-blown trade war between the US and China have been appeased by the ongoing negotiations and, most importantly, by investors focusing on the good figures printed by corporates and the strong US economic fundamentals.

Hence US equities outperformed the rest of the world. Small and mid-caps, more domestically oriented, outperformed large caps, which are more sensitive to external trade tensions. The technology sector was the best performer, with the Nasdaq 100 returning over 6% during the month. It was closely followed by consumer discretionary and healthcare, which returned around 5%. The main indices from Europe, Asia ex Japan and Emerging Markets finished the month in the red. Investors are worried that trade tensions might derail the ongoing positive economic dynamic and slow these economies down.

Developed countries’ fixed income markets were calm, with the only thing to highlight being the slight easing of medium-to-long-term rates in the US and Europe. Canadian short-term rates took on an average 10bps, with investors anticipating imminent action from the central bank. Short-term rates in Argentina, Turkey and Brazil continue to widen very strongly.

The US dollar posted small gains against major developed market currencies, while continuing to appreciate strongly versus currencies like the real and the Argentinian peso. The Yen, it should be stressed, remains weak, a deviation from its usual role of safe-haven currency in periods of Emerging Market turmoil.

Commodities seem to correlate to EM weakness with bearish trends on agricultural goods and precious and base metals. Relatively, oil remains strong, supported by a production weakness and by the inability to route increasing shale production to the refiners. Brent increased by +4.27% to $70, building a spread to WTI of close to $10.
The HFRX Global Hedge Fund EUR was up 0.17% for August.

Long short equity

During the month of August, long/short equity fund performance was dispersed. US-focused funds outperformed funds investing mainly in Europe and Asia. August’s market index performances were strong but the moves were pushed by a limited number of sectors and big market-cap names. This tended to affect the hedge fund’s capacity to generate alpha, producing poor upside capture ratios. Shorting stocks was also a difficult business during August. However, there are still a lot of opportunities within sectors like healthcare, technology, media and consumer, where, every day, technology enhancements allow a secular leader to be challenged by a new competitor with a new technology or more cost-efficient business model.  

Global Macro

August was a difficult month for global macro investors, especially those focusing on Emerging Markets. Asset moves were violent but investors had not yet capitulated on the value offered by the strong pricing discounts. According to a recent Morgan Stanley Prime Brokerage survey, volatility, central bank activity and higher rates are generally viewed as positive for Global Macro managers. Geopolitics, on the other hand, is viewed as the biggest negative.    

Quant strategies

Trend-following strategies, benefiting from trends across all asset classes despite unclear market movers, present positive returns. It shows once more the strength of the strategy in an unpredictable environment. In the meantime, quantitative equity strategies strongly performed, reversing some of June’s losses, on the back of increasing equity market dispersion.

Fixed Income Arbitrage

Managers’ returns were positive, despite a low level of volatility on interest rates. This strategy offers an interesting opportunity as its positive convexity bias will benefit from a more volatilie environment. Since the beginning of the year, all managers in this space have delivered strong risk-adjusted returns, while being positively exposed to volatility.

Emerging markets

In 2018, Emerging Markets have been a very scary place to be invested in. It seems that everybody hates it and there is always a good reason to sell it. The ongoing tariff dispute between the US and China is keeping the pressure on every asset class and that may continue until the US elections in November 2018. While the timing of the resolution of most of these problems is unkown, the dislocations created by Donald Trump’s policy will, at one stage, become opportunities.

Risk arbitrage – Event-driven

Merger arbitrage strategies, benefiting from a healthy market, generated, on average, positive returns. Nevertheless, aggregated deal volumes were down from July due to the slowdown during the holiday period. As no major events affected deal spreads, performance was generated by managers’ idiosyncratic deal selection. Still, looking to the second half of the year, the outlook for merger arbitrage remains favourable. Pending transactions generally have strong strategic rationales and highly committed buyers.

Distressed

We believe that we are in the late stages of the credit cycle, with default rates and spreads near historical lows. Nevertheless, although we are closely monitoring distressed managers, due to the potential for high expected returns, we broadly remain on the sidelines. We see a growing number of US hedge funds specializing in distressed assets that are starting to raise money in anticipation of the next economic downturn.

Long/short credit & High yield

After several months of outflows and marginal-spread widening, the US high spread went back to its tightest spread level, supporting our negative view on the strategy.