There cannot be said to have been no bad news in October; the market, however, preferred to focus on the good news. Venezuela’s default remained contained locally and the Catalan parliament’s quest for independence did not trigger a generalized market sell-off.
Equities remained supported, with the world growing altogether at its fastest pace in a long time. Japan was the positive outlier, with the Nikkei 225 returning +8.13%. Sovereign yields did not move much. Even though the Fed manifested the will to pursue a rate normalization path, the spread between the 2 and 10y US rate remained low – possible proof of investors waiting for stronger inflation data. For commodities, WTI gained slightly over 5% following political tensions on the Middle East. Precious metals were flattish, copper and steel were down on an expected demand decrease. Cobalt and palladium were among the few strong increases due to the enthusiasm for electric vehicles. In October, the US dollar appreciated in value against most currencies. It gained 1.65% vs the EUR, finishing the month at 1.165.
HFRX Global Hedge Fund EUR index was up +0.50%.
October was, on average, a good month for long/short equity managers. There was, however, some dispersion among regions and styles. The US and Asia were net buyers of equities while European funds were net sellers, reversing last month’s trend. In the US, technology was the most-bought sector, bringing a positive tailwind for tech specialist managers, whereas healthcare managers did less well due to the underperformance of their longs versus shorts. While Asia funds have brought down gross exposure by selling some technology stocks, the region did well, especially with the contribution of Japan following Shinzo Abe’s re-election. European markets were more flattish, due possibly to the Spanish political crisis and Germany’s potential dead end in their attempts to form a government. A lot of European managers remain convinced that the current economic robustness, including a European equity underweight in portfolios and valuations that are relatively cheaper than other assets, makes it a very compelling investment opportunity for the coming quarters. This they are expressing by increasing their net exposures to European cyclicals at the expense of defensive stocks considered to be priced for perfection. The recent normalization continues to unfold and investors have more information on the pockets of uncertainty that were causing concern. Trump’s Administration has officialised its new choice to chair the Board of Governors of the Federal Reserve: Jay Powell. Also, the ECB validated the expected scenario of the QE programme reduction from January 2018 onwards while maintaining a dovish stance regarding a possible extension of the programme.
Global macro managers’ returns were dispersed during the month. Systematic managers tended to outperform due to their long equity index positions (the main performance contributors for the month). Negative outliers were mainly funds with long exposures to Puerto Rico bonds. Due to the current transition phase of the central bank support programmes, the funds’ positioning tends to be very heterogeneous, leading to performance dispersion. 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. The long-term models were less affected by recent short-term market sentiment reversals. Apart from during 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 represents 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. Despite increasing rhetoric from central banks that should ultimately lead to higher rates, volatility remains subdued. Access to balance-sheet lines in the US hasn’t been a problem in recent months as opportunities have shrunk. However, we remain confident on the strategy as Europe and Japan still offer compelling opportunities.
Year-to-date, our EM macro managers have been successful in generating returns in Asia and Latin America. During October, despite liquidity events in Puerto Rico and Venezuela, these crises remained contained locally. Most of our managers managed to print positive returns, apart from one fund with a significant investment in Puerto Rico. 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 is not affected by political missteps, the number of transactions could increase whenever 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 getting closer to the so-much-anticipated tax reform. Even though there is increased optimism in Congress’ ability to deliver, there is still a lot of uncertainty surrounding the details. In M&A strategies, we favour less static and more spread-trading-oriented managers.
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 offer plenty of dislocations within the sector.
Although the quest for yield and the zero-to-negative rate environment are still providing strong support for the asset class, volatility could spike if rapid changes in monetary policy surprise the market.