External alternative multi management portfolios - November 2016

Attention focused on the US presidential elections last month. Corporate earnings were not as bad as expected, giving investors some hope that some regions like Europe could see further improvement.

Equities moved mainly on sector rotation away from defensive high yielding stocks and towards cyclicals with better growth prospects. This trend was driven by a wider acceptance that QE policies are not having the desired impact on the economy and the more than probable Fed rate hike in December. The expected move from monetary to fiscal stimulus will create upward tensions on inflation and rates. As a consequence, bonds, generally, came under pressure over the period with sovereign rates tightening in most DM and EM regions.

Early in october, the dollar began to rally against all major currencies.

In this environment, HFRX Global Hedge Fund gave back ‑0.75% in October 2016.

We are neutral on the strategy due to the unstable correlation among factors and heavy sector rotation. We have selectively dialled down exposure in response to the difficulties experienced by some of our more fundamental-driven managers. The recent renormalization benefited our selection of L/S market neutral managers.

Global Macro

As mentioned above, global government bond yields rose in October. The US dollar strengthened against most currencies, especially against the GBP and the EUR. Our main macro manager strongly benefited from these moves. Looking ahead, the Trump government policies will have a substantial impact on domestic and overseas economic conditions. In anticipation, significant shifts in asset prices will occur. We believe the macro strategy will be able to capture and benefit from these wide market moves.

Quant strategies

We continue to favour short-term managers that may benefit from increasing trading flows and volatility as global investors will need to shift their portfolio allocation to adjust to the changing macroeconomic conditions (as mentioned above in the macro section). And we continue to avoid slower strategies that have become crowded due to their success in recent years. 

We are increasing our fixed income arbitrage allocation. The recent US election and the forthcoming elections in several European countries have increased volatility on interest rates which will benefit the strategy. Our managers are benefiting from European basis trading and the widening of US swap spreads in the run-up to the money market reform. There are fewer opportunities on the JPY RV side.

As a reminder, we do not view or invest in emerging markets as an asset class to benefit from the rise of EM equity or debt markets while the asset class is in fashion among investors. On the contrary, we are happy to see the rise of ETFs investing (or exiting) on mass in these markets as they buy (or sell) indiscriminately quality and poor stocks or credit, creating price dislocations that tend to mean-revert to fundamentals over time. Heavy flows from corporate hedging activity (commercial trades, acquisitions, funding) also provide a major source of price dislocations in the forex, fixed income and equity derivatives markets. We look for managers who can exploit these price dislocations by investing in idiosyncratic ideas in equities and trade country-specific, or relative value opportunities, while they run portfolios that are not too sensitive to the overall direction of emerging markets. On top of these price dislocations, there are currently interesting dynamics that are unfolding at many levels (over-supply in commodities and shipping; slowdown in the supply chain that serves developed markets products, rising domestic demand; shifting to value-added exports, withdrawal of liquidity, over-indebtness and slowdown of fixed asset invesments) yielding opportunities for thematic investing.

While we believe that this strategy continues to make sense, its net long bias nevertheless puts it at risk in cases of strong market turbulence. Even if risk/reward is proving less profitable now than in recent years, our managers posted strong returns in Q3 2016. We are exploring investments in European event managers that will benefit from the need to bolt-on growth.

In M&A arbitrage, we favour less static and more spread-trading oriented managers as average margins among deals have compressed significantly.

Distressed

We are more constructive on the distressed cycle with the potential increase of interest rates and the reduction of QE. So far the energy sector, in which massive issuance has taken place in recent years, provided an attractive pool of opportunities given the volatility of oil prices and its impact on these securities. Emerging markets may also offer some opportunity due to the strength of the dollar and the hike in interest rates. 

We remain cautious on the strategy, although the US market has been more challenging than Europe. The quest for yield and the zero-to-negative rate environment have provided strong support for the asset class and delivering performance on the short side is highly challenging.