During this first quarter, the Federal Reserve proceeded with a widely anticipated interest-rate increase concurrent with a weakening of the Trump trade.
Global equity markets were mixed, with Nasdaq and European gains offset by narrow declines in US large-cap & Energy-sector exposure. US rates increased modestly for the month across most maturities, while European yields also rose following Brexit developments and the Netherlands election. Commodity declines were led by Oil, Copper and Platinum, which were partially offset by increases in Natural Gas, Aluminium and Cocoa. The US Dollar declined against most currencies despite the Fed increase, falling modestly against the GBP, the Euro and the Swiss Franc.
In this context, the HFRX Global Hedge Fund Index returned -0.17% for the month.
We have maintained our neutral stance on the strategy, due to strong investment-style reversals brought about by political uncertainty. The recent renormalization continues to unfold and we are progressively transitioning to more pro-cycle managers, who, we believe, are likely to be best positioned to take advantage of the possible pro-business policies expected from the new administration in the US.
Over the past quarter, stock markets in advanced countries – spurred on by expectations of fiscal stimulus and deregulation in the US and by solid incoming data – strengthened further. This optimism slightly faded towards the end of the quarter as the Trump administration could not pass legislation on its new healthcare reform. Making America great again will take longer than initially thought. Even though the outcome of the Dutch election maintained market stability, many other political and economic uncertainties remained (elections in France and Germany, credit in China, …). As mentioned previously, we believe significant shifts in asset prices will continue to occur as anticipations adjust to realities. Macro strategies will be able to capture and benefit from these wide market moves thanks to increasing volatility on rates and FX. Our Global Macro bucket may balance our net long exposure as it invests in different risk factors to our equity funds.
In general, quant strategies performed poorly in 2016. In Q1 2017, with the exception of the few managers that suffered with their short-term models, most managers in CTA, Equity Statistical Arbitrage and Fundamental Quant Equity Market Neutral posted flat-to-positive returns. Market volatility continues to be low. Higher volatility will help increase the number of opportunities.
We are increasing our fixed income arbitrage allocation. The US election and the elections in several European countries increased volatility on interest rates. Our managers benefited from European basis trading and the widening of US swap spreads; conversely the dust is settling after the US money market reforms (Q4 2016) and the US Libor / OIS spread-tightening. There are fewer opportunities on the JPY RV side.
If emerging markets offer plenty of investment opportunities across asset classes (currency, interest-rate curve, single-name equity and debt), the market has come closer to fair value after an 18-month rally. To exploit these opportunities, we have invested in global macro managers, some specialized in one given region, e.g., Asia, and in local managers that carry out fundamental analysis and make on-site company visits to pick stocks.
We are turning more positive on the strategy even if we remain mindful of the risks linked to the net long bias of event managers. The number of transactions could increase if some degree of deregulation is put in place. In such a case, large cash balances earmarked abroad by US corporations could be repatriated and possibly used for acquisitions.
Investments in European event managers that we are exploring 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 spreads among deals have compressed significantly.
We are more bullish on the distressed cycle, 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. Emerging markets may also offer opportunities due to the strength of the dollar and the hike in interest rates.
We remain cautious on the strategy, as the asset class is driven more by the direction of the interest rate than credit spreads. The quest for yield and the zero-to-negative rate environment will still provide strong support for the asset class, and delivering performance on the short side is highly challenging.