The overall picture for riskier assets in the market remained positive in April, as the world economy continued to recover and major central banks maintained their dovish tone. Joe Biden decided to hit hard and strong right from the start of his mandate, not only with significant stimulus programmes but also with his proposal to revise the US tax code by increasing domestic tax rates and decreasing international tax schemes for multinationals.
During the month, most equity indices, supported by improving macro data points and strong earnings, performed well. Taiwanese equities were a strong performer, as its economy its closely linked to the booming semiconductor industry. Technology stocks rebounded strongly during the month.
Contra-intuitively, the highly scrutinized US long-term rates eased by 10-to-15 bps during the month for maturities equal to or above five years, despite positive data points and additional stimulus. Without trying to make too much of this move, it seems to be linked to market participants taking profits on their short-rate positions.
Commodity futures continue to rise, more specifically, industrial metals (which are linked to the economic recovery) and energy, and soft commodities like corn.
The HFRX Global Hedge Fund EUR returned +1.52% during the month.
Long Short Equity
April was a good month, in terms of performance, for Long Short Equity strategies. Although technology growth stocks rebounded after a difficult first quarter, the winning thematics of 2020 remained challenged, as investors continued to rotate part of their allocation into cyclicals. On average, funds generated decent positive absolute returns versus equity indices. Compared to Europe- and Asia-focused funds, strategies focused on the US had lower upside capture ratios. This is not surprising, as these have heavier exposure to growth technology and healthcare sectors, both of which have underperformed the broader market so far this year. On average, alpha generation was positive during the month, mitigating one of the worst starts, in terms of alpha, of the last 10 years. According to Morgan Stanley Prime Brokerage, total alpha since the start of the year is in negative territory, at low double digits due mainly to the outperformance of the short books. Sector-wise, the most net-sold sectors in the US were semis, financials and healthcare providers & services. Although US hedge funds have been adding to European equities, mainly in cyclicals and financials, investment levels remain far from pre-COVID levels. Long Short Equity is a strategy that is diverse and rich in terms of thematics and style, and possesses several tools to face different market environments. monthly
It was, on average, a positive month for both systematic and discretionary strategies. The latter tended to outperform the former, with many strategies benefitted from the recovery in going long rates in Brazil and South Africa, a decision which caused pain during March. Overall, while the easing on US rates generally detracted from performance, this was offset by long positions in equity futures and commodity baskets, and by short European rates. For the last 3 years, Global Macro managers - specifically, discretionary strategies - have managed to take advantage of these turbulent and volatile markets to print some decent returns. We continue to favour discretionary opportunistic managers who can draw on their analytical skills and experience to generate profits from selective opportunities worldwide.
Quantitative strategies delivered good returns for April. Trend models continued to benefit from momentum on equity and commodity futures, and statistical arbitrage models from factor volatility. Equity market-neutral models drove positive contributions from value, quality and momentum. Purely price-driven arbitrage strategies had more dispersed results. Sophisticated multi-strategy funds - less dependent on a specific model - continued to be better positioned to navigate different market environments and post interesting returns.
Fixed Income Arbitrage
Despite 10-year US rates plateauing around 1.60%, the healthy dynamic for the basis trading was overshadowed by (a) technical aspects (temporary exclusion of Treasuries from the Supplementary Leverage Ratio (SLR) calculation), (b) some profit-taking on steepeners and (c) the directional positioning. On the European side, the ongoing market dynamics supported good P&L generation. Going forward, the environment will be driven by ongoing technicals, central bank intervention and inflation uncertainty (while the reopening is gaining momentum), which could all weigh on the strategy, despite a healthier environment.
On average, Emerging Market strategies performed well during the month. The ongoing recovery of the world economy is contributing to push commodity prices up, which is a positive tailwind for export-driven countries and is helping improve fundamentals. The easing on Brazilian long-term interest rates helped hedge funds recover part of the losses caused by the 1%+ upward move in March. China equities, a strong performer last year partially due to a relatively quick recovery from the COVID crisis, remain relatively muted this year. The central government crackdown on some large companies and tighter monetary management by the People’s Bank of China helped take some steam out of the system. With a significant part of the global bond market in negative-yield territory, Emerging Markets are an appealing investing ground for investors seeking decent fixed income assets. Although EM fundamental managers reckon the space is an interesting option in a zero-rate world, considering the fragility of fundamentals, they usually adopt a very selective approach. Caution is required, due to the higher sensitivity of the asset class to investor flows and liquidity.
Risk arbitrage – Event-driven
Event-driven strategies performed well during April, displaying some of the best risk-adjusted returns YTD. Deal volumes remain healthy, with average deal spreads presenting an interesting low-double-digit annualized return. Managers believe this may be one of the most interesting strategies for 2021, as equity markets might have priced in most of the recovery, and periods of higher volatility may lie ahead as the market juggles with two contradictory forces: optimism for the future on the one hand and, on the other, some good levels of bubbles in the market, fed by generous liquidity injections. Merger-deal activity is expected to continue in the near future. Interest rates, although rising, remain, in absolute terms, low. Corporations have cut costs and issued debt and equity not only to face the crisis, but also to be ready to snap up strategic assets. Activity is driven by the need to restructure in stressed sectors like energy and travel, the willingness for consolidation in healthcare, financials and telecom, and the need to adapt to today’s new reality by externally acquiring technologies that would take too much time or money to develop, like in the semiconductor space.
Stressed and distressed strategies did well during the month, benefiting from idiosyncratic profitable trades and a positive risk-on sentiment. The last 12 months have been, on average, the highest performance period since the Great Financial Crisis (GFC) of 2008. The COVID crisis, managers believe, although very different by its origins and its impact, will be a source of opportunity for years to come. During the GFC, the market dealt with a financing crisis following the collapse of major financial institutions; the current financial landscape is characterized by relatively sound financial institutions but where bank financing, by force of regulation, has been replaced by support from non-banking financial institutions like hedge funds. The opportunity-set is hence wide and varied. We favour experienced and diversified strategies to avoid having to face extreme volatility swings. It is not going to be easy but this is the environment and opportunity-set these managers have been waiting on for the last decade.
Long short credit & High yield
Following the market crash at the end of the first quarter of 2020, hedge funds have opportunistically loaded on IG and HY credit at very wide spreads. Managers that were able to go into offensive mode were aggressively buying on the market or making off-the-market block trades, whereas other managers, unable to meet margin calls, needed to quickly cut risk. Since then, spreads have completely reversed to pre-COVID levels. Multi-strategy managers have significantly reduced exposure to credit and high yield, as current valuations present limited expected gains and a negative risk-return asymmetry.