It may seem puzzling that, after a market crisis without precedent, some parts of the market are almost back at pre-crisis levels even though visibility is as low as before. Uncertainty regarding the economic impact of the shutdown is still very high and, also, the impacts generated by changing consumer trends have yet to be quantified.
Equity indices – driven by investor flows flocking to technology and healthcare thematics, equity short-covering and massive liquidity injections – rebounded strongly during the month. As usual, the biggest equity moves took place in North America, with the Nasdaq 100 and Nasdaq Biotech Indices up around +15% over the month. Aggressively sold markets also rebounded strongly. The Argentinian Merval Index was up +34.28% while the S&P 500 Energy sector returned close to 30% versus +12.68% for the S&P 500 Index. Rebounds in southern Europe equity indices, UK large caps and in Japanese and Hong Kong equity indices were more modest, posting a positive mid-single-digit performance.
Credit, especially in the US, made a strong comeback. US Investment Grade and short-term High Yield issue spreads, supported by the Federal Reserve programmes, rallied strongly. In Europe, the focus is on Italian sovereigns, where, despite the ECB’s efforts, borrowing rates remain volatile, continuing to trend upwards.
The HFRX Global Hedge Fund EUR gained +2.47% over the month.
Long short equity
LS Equity strategies were, on average, positive. However, considering the strong equity market returns, the upside capture ratio was relatively weak. This was mainly due to the strong rebound brought about by short covering low-quality stocks on short books. Low net exposure and market-neutral strategies hence tended to underperform directional equity funds. On average, gross and net fund exposures decreased during the month due to managers selling longs into the rally and covering short positions. Due to high levels of macro uncertainty, market breadth is low, concentrating winning trades on a low number of stocks and themes. LS Equity strategies are well positioned to benefit from investment thematics in the technology and healthcare spaces. Sustainable and ESG-driven strategies, although still relatively fresh topics in the alternative space, seem to be gathering momentum and to be exiting the crisis strengthened. It will take some time for corporate management and investors to gain more visibility on the real impact that social distancing measures will have had on revenues and will be dependent on many variables (e.g., government social distancing rules going forward, finding a treatment, the success of stimulus measures, additional epidemic waves). Finding a solution to the current crisis is therefore not a binary call that can be solved overnight. Long Short Equity strategies are, in our opinion, an interesting strategy to consider for navigating the current market environment, since they can modulate their risk appetite and generate returns from their long and short positions in a very wide range of investment themes. Good stock-pickers will be able to select winners and losers.
Performances were relatively dispersed but, overall, positive for Global Macro managers, with discretionary strategies generally outperforming systematic investment programmes. Discretionary managers were able to benefit from short-term tactical trades and made money receiving rate positions in selective EM countries and from being long equity indices. However, considering the high speed of market movements that we experienced in March, the performance that managers printed during the last 2 months reflected their pre-crisis positioning, the level of concentration of their investments and their ability to tactically adjust their portfolio to the current reality. Liquidity has hence been key to navigating this year’s market. Considering the high volatility levels and future uncertainty, fund managers are focused on reassessing current positions and reducing risk. The massive stimulus programmes announced by central banks and governments all around the world should help stabilize the market. However, until the current health crisis is contained and we learn to live with it, the outlook will be foggier. In this environment, we tend to favour discretionary opportunistic fund managers who can draw on their analytical skills and experience to generate profits from a few strong opportunities worldwide.
CTAs were among the best-performing quantitative strategies YTD. Going into April, these strategies were positioned mainly on short equity indices, short commodities and long fixed income assets. Recent sharp market reversals negatively impacted medium- and long-term trend models. More generally, quantitative models had difficulties dealing with the violent and rapid increase in market volatility and asset correlations between the end of February and April. The extreme and prolonged volatility levels reached during March led to a significant deleveraging of quantitative strategies, generating poor performance and leading to more deleveraging. The implementation of the stock-shorting ban on some European countries helped accentuate the deleveraging effect because managers were unable to implement or adjust the optimal portfolios of long and short securities as defined by their model.
Fixed Income Arbitrage
If Fixed Income relative value had one of its most spectacular months in history in March 2020, it highlighted the need to be invested in managers with strong set-ups. At the end of March, our managers took advantage of the dislocation within the US basis to post strong positive returns. As we come closer to the June expiry, they will roll their basis positions on the September expiry, which seems quite attractive. Like other RV trades, spreads are wider than they were pre-crisis, and we reiterate our positive stance on the strategy.
April was very positive for most Emerging Market assets. Equity indices rebounded sharply and sovereign rates – driven by oversold asset levels and improving market sentiment – rallied. Considering early-2020 investment outlooks, this asset class suffered probably the most brutal turnaround in the financial spectrum. Instead of weighing EM premium rate risk versus Developed Markets, investors are now considering risks linked to the notional and interest-rate haircuts of over-levered countries and economies too dependent on oil exports. Uncertainty is still very high but life will find its way. The market is cyclical and, as such, current massive dislocations are the seeds of future investment opportunities at more interesting entry points. Nonetheless, we remain cautious about the strategy because, on top of fundamental considerations, EM assets might suffer from outflows of capital chasing opportunities in DM High Yield, and from a lack of liquidity.
Risk arbitrage - Event-driven
April was a strong month for Event-Driven strategies. During the crisis, deal spreads, which widened violently, reflecting an “End-of-the-World” scenario of high uncertainty in deal-closing probabilities, were also negatively impacted by excessive concentration and the book-size reduction of some managers. The managers we talked to were quick to reassess their portfolio of deals to concentrate their book on strategic deals with strong merging contracts and unload high-levered deals or non-strategic deals with Private Equity Fund bidders. This played out nicely, with Merger Arbitrage strategies recovering a substantial part of March’s losses. Over the short term (60 to 90 days), managers, although relatively optimistic about the investment opportunity, are selecting deals carefully and closely tracking management’s commitment to the merger or the acquisition. They will also carefully look for any financing problems or contract clauses allowing the buyers to easily walk away from the deal. The average embedded deal spread has retraced substantially, but still offers a decent expected return in a relatively liquid investment opportunity. This will vary for each strategy, depending on portfolio concentration, leverage and deal risk. It is, however, an interesting entry point for a liquid strategy with clear catalysts when investing in announced deals.
Distressed opportunities have finally arrived but not in the way we were thinking of. Instead of reaching the end of the credit cycle progressively, the coma-induced world economy made businesses crash against the wall at a high speed. The question is therefore not about whether there will be distressed opportunities, but about how many? Apologies if we seem insensitive at a time of great difficulty for many people around the world. We hope that the monetary and fiscal stimulus plans being put together will be effective and limit the damage to our economies. However, it is a fact that they will not be able to save every business in the world. From the discussions we held with experienced managers, we gathered that credit was being sold off with aggressive quotes not only for fundamental reasons but also due to a lack of liquidity. Distressed managers are not rushing to dive right in. Assets being sold require deep fundamental analysis to be bid at the right price.
Long short credit & High Yield
Credit spreads for Investment Grade and High Yield markets reached extreme levels unseen since the crisis of 2008. The market was also highly affected by the lack of liquidity, prompting the ECB and the Fed to step up their IG debt-purchasing programmes. The Fed also decided to include High Yield in its buying programmes to smooth the high amount of Investment Grade fallen angels downgraded to High Yield. Rating agencies forecasted that the amount of fallen-angel debt could reach $700 billion in the US, probably too big to be absorbed by the HY market smoothly. Investment Grade and short-term High Yield issue spreads reacted very quickly to liquidity injections, especially in the US. According to the managers we track, while this move in higher-quality issues was widely expected, there are still many opportunities in High Yield but also in the cross-asset relative value trades (long bond vs short equity) generated by the market dislocations. Contrary to 4Q 2018, opportunities offered in credit will take longer to be arbitraged, leaving time for investors to review their allocations.