America First policies continue to be one of the main investor sentiment drivers around the world. The threats of unilaterally imposed tariffs imposed by the Trump administration are maintaining an uncomfortable level of uncertainty. Alongside, Argentina and Italy had a significant wake-up call leading to a substantial re-pricing of their financial assets.
During the month, US equities outperformed the rest of the world. The S&P 500 was up 2.16% and the Nasdaq, helped by the good behaviour of technology stocks and the growth style, increased by +5.48%. European stocks sold off on Italian political concerns. The MSCI Europe (-0.64%) was slightly down, whereas the Euro Stoxx 50, more heavily biased towards financials, declined -3.67%. Unsurprisingly, the FTSE MIB underperformed the other European indices, losing -9.15%. Latin America did not do well during the month, following Argentina’s rate hike and the general EM market risk-off. Argentina’s Merval Index was down -4.14%, whereas the Ibovespa and Mexbol Indices were down -9.22% and -6.47% respectively. In Asia, the Taiwan Stock Exchange Index, helped by the recovery of semiconductors, outperformed.
On the fixed income side, the main event was related to the re-pricing of Italian issues. The BTP yield curve widened significantly, with medium-term issues rates increasing over 100bps. A flight to quality led German medium-to-long-term yields to ease by around 20bps. The dollar strengthened against all major currencies, gaining, for example, +3.55% versus the Euro. The Argentine and Turkish currencies paid the price for economic or political weakness, losing -17.40% and -10.33% respectively.
The HFRX Global Hedge Fund EUR index, at +0.01%, was flat.
The long/short equity fund performance was, on average, good during the month, thanks mainly to the alpha on their long positions. Nevertheless, technology long/short strategies did particularly well, benefiting from the recovery in the semiconductor space. Also, managers with a growth style bias tended to outperform fundamental value managers. Long/short equity managers are an interesting investment proposal because they have more tools with which to take profit from this late-stage economic cycle. Their lower net exposure will offer a structural protection against market drawdowns, and short bets on challenged industries or pricy valuations will add value to fund returns.
May was mainly beneficial to managers with a bearish mindset, who were rewarded by short positions in Emerging Markets, more specifically Turkey and Argentina, and peripheral Europe. It was a month of strong dispersion among managers, with a couple of funds hitting the headlines due to their strong outperformance or underperformance. We still think that our global macro strategy offers a wide range of investment possibilities that, in theory, should benefit from the current asset risk-repricing. The economic cycle inflexion will offer opportunities in asset classes like fixed income by taking directional bets, long or short, or relative value plays to benefit from the widening credit spreads. Macro strategies will be able to capture and benefit from these wide market moves.
The market environment and increasing volatility have put further pressure on trend-following and systematic macro. However, increasing equity volatility has been supportive of equity relative strategies, whether price-driven or fundamental-based, which posted robust returns in May.
We kept our fixed income arbitrage allocation at the same level. Despite some opposing dynamics in the interest-rate markets, the equilibrium between buyers and sellers of US treasuries has left little room for basis or futures roll-down arbitrage.
The Libor/OIS spread, having reached historically high levels in April, retraced by 20bps. In the meantime, US swap spreads on the 10-year have retreated from negative territory and the short-term cross-currency basis has tightened.
Conversly, the European market has been more turbulent, especially on the peripheral side, where the Italian market triggered a strong core-peripheral spread widening.
YTD, all the managers in that space delivered strong risk-adjusted returns while positively exposed to volatility.
Risk-off sentiment spread from countries like Argentina and Turkey to the rest of the Emerging Markets. Investors are concerned by the effect the strong dollar will have on economies with a high percentage of USD-denominated debt. On average, hedge funds were net buyers of Emerging Market assets and profited from the correction to buy longs in Latin America and Asia. Although we think that Emerging Markets will continue to offer a wide range of investment opportunities across asset classes (currency, interest-rate curve, single-name equity and debt), we will continue to closely monitor the situation.
Event-driven managers’ performance was, on average, positive during the month. Within the event space, Merger Arbitrage strategies had a particularly good month. Markets had the sentiment of tensions easing between China and the Trump administration. This helped deal spreads tighten, after their widening last month for the opposite reasons.
We are closely monitoring distressed managers, due to potentially high expected returns, but remain broadly on the sidelines because the current environment continues to favour pushing the can down the road in repricing risk. The market is starting to reprice risk but the very tight spreads offer a negative risk asymmetry. High yield saw important outflows and spreads widening after February’s sell-off but the trend has reversed.
The quest for yield has been severely challenged since the beginning of the year both in Europe and in the US. The environment is challenging due to the increasing level of volatility and the lack of visibility on the two major zones at different times of the credit cycle. Consequently, we remain very cautious in that field.