With North Korea in the rear mirror, investors focused a bit more on fundamentals, which are not that bad. Most major economies are growing simultaneously, interest rates remain low and inflation is getting closer to central-bank targets. The market was also carefully scrutinizing news from Washington to try to anticipate the widely expected tax reform to be announced by the Trump administration.
This was maybe what triggered the reflation-trade comeback. Most equity indices were up strongly, apart from markets like the FTSE 100 and Borsa Istanbul, due to political instability. Sector-wise, cyclicals outperformed consumer staples and utilities. US and most European sovereign mid- to long-term rates tightened, with the US 10y treasuries yield having reached 2.33% by the end of the month. Precious metals underperformed in this flight from safety, and oil gained almost 10% in 1 month, with crude oil WTI reaching $52.
The HFRX Global Hedge Fund EUR index was up +0.39%.
On average, long short equity managers posted positive performances in September. The strong rotation out of growth and defensive sectors into value and cyclicals benefited industrials and materials at the expense of utilities and consumer staples. Energy stocks were pushed up by the oil-price rally. The total alpha generated declined, due to short positions outperforming longs. This made it more challenging for market-neutral funds to print positive performances. Europe long short equity managers with a net long bias had a positive tailwind, since September was the largest month YTD of net purchases of European equities, particularly in the case of those with a bias for cyclicals. In the US, Treasury Secretary Steven Mnuchin warned that, if the anticipated tax reform failed to materialize, the failure could have a negative impact on stock-market gains. In Europe, the ECB continues to manage with caution communication regarding the changes to be made to its stimulus plan. There are concerns about the Euro’s current strength and its potential negative impact on the recovery of the European economy. Nonetheless, the recent normalization 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 administrations in the US and Europe.
Global macro managers’ returns were dispersed during the month. Discretionary strategies did better than systematic investment processes due to their capacity to adapt quicker to a changing environment. Sharp reversals on commodities, fixed income and, to some extent, currencies, weighed negatively on performance. Most discretionary managers with significant positions in Puerto Rico debt and long positions in Turkish equity and currency were down for the month. Discretionary managers were able to navigate 2017 more smoothly than systematic managers, who had a hard time making money on currency, commodities and fixed-income positions. We believe significant shifts in asset prices will continue to occur as anticipations adjust to reality. 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.
Since the beginning of the year, quant strategies have had difficulties posting positive returns. Long-term models were less affected by the recent short-term market-sentiment reversals. Apart from sporadic events like the North Korean tensions with the United States during the summer, volatility indices in the US and in Europe remain close to all-time lows. This is a negative tailwind for most strategies. Short volatility remains a positive strategy but, overall, higher volatility would increase the number of opportunities in our quantitative bucket .
We kept our fixed-income arbitrage allocation at the same level. Following the French elections, the spread between Germany and France reduced and European swap spreads returned to their December 2016 levels. Conversely, volatility on interest rates has, since then, risen slightly in the Euro zone.
The US Libor / OIS spread reverted to its historical lows and former price regime.
Year-to-date, our EM macro managers were successful in generating returns in Asia and Latin America. During September, some of our managers – driven by long bond positions in Puerto Rico and long bets on Turkish Lira – posted negative returns. Nonetheless, emerging markets still offer plenty of investment opportunities across asset classes (currency, interest-rate curve, single-name equity and debt).
We are more positive on the strategy even if we remain mindful of the risks linked to the net long bias of event managers. If business leaders’ confidence remains unaffected by political missteps, the number of transactions could increase if some degree of deregulation is put in place in the US and also in Europe. In such a case, large cash balances earmarked abroad by US corporations could be repatriated and possibly used for acquisitions. We seem to be closer to the much-anticipated tax reform, with a blueprint to be announced by the US administration at the end of October.
Investments in European event managers we are exploring will benefit from the need to bolt on growth. In M&A strategies, 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. Traditional brick-and-mortar retailers are being seriously affected by technology innovations and this offers plenty of dislocations within the sector.
The quest for yield and the zero-to-negative rate environment are still providing strong support for the asset class but volatility could spike if rapid changes in monetary policy surprise the market.