The risk of a trade war between the US and China triggered another equity sell-off in March, making equities the main asset responsible for the increased market volatility levels. Quite unusually, technology stocks added to the sell-off instead of acting as a support for market valuations.
There was really no place to hide on the equity markets. Almost every equity stock index was down between 2% and 3%. Brazil was once again the outperformer, posting a flat return. Utilities and consumer staples were the outperforming sub-sectors. Cyclicals were the hardest hit by the tariffs menace and technology stocks were dragged down by Facebook’s corporate governance issues.
The Fed, as expected, raised short-term rates by a quarter point. However, despite Jay Powell issuing a rather hawkish statement raising the Fed’s forecasts, US mid-to-long-term Treasury prices rose, with yields decreasing 0.10% to 0.15%. European and British rates followed a similar path. The dollar lost around 1% against the Euro, the Yen and Sterling. Tariffs impacted commodity prices, with base metals suffering the most. The iron ore price decreased 20%, copper, platinum and aluminium lost around 6%, while palladium lost close to 10%. Oil was a winner, with the WTI up 5.35% for the month.
The HFRX Global Hedge Fund EUR index was down -1.25%.
The equity sell-off continued into March, with most equity indices losing on average 2 to 3%. The tariffs discussed by the Trump administration raised a degree of uncertainty that the markets obviously did not like. Another important event influencing hedge fund performance was the scrutiny of Facebook’s business model, which dragged most of the technology sector down. Long/short equity managers’ performance was dispersed. On average, strategies with a market-neutral bias outperformed long bias funds.
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.
The Global Macro strategy offers a wide range of investment possibilities that, in theory, should benefit from the current asset risk repricing. For so long, these managers were having troubles dealing with Central Banks’ put and the lack of market volatility. 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 any credit-spread widening. Macro strategies will be able to capture and benefit from these wide market moves.
The market environment and increasing volatility haven’t been really supportive of 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 March.
We kept our fixed income arbitrage allocation at the same level. Increasing equity volatity has filtered through interest rates. After more than a month of bond sell-offs, the market seems to have paused on the back of a potential economic slowdown generating significant volatility on both a swap-spread and a futures basis, generating significant opportunities.
If access to balance-sheet lines in the US hadn’t been a problem till year-end 2017, the first quarter saw the Libor/OIS spread reaching historically high levels due to heavy Treasury issuance, which put pressure on USD bank funding. In the meantime, US swap spreads on the 10-year went back into negative territory and the short-term cross currency basis has tightened.
YTD, all managers in that space delivered strong risk-adjusted returns while positively exposed to volatility.
Latin America countries – pushed by improving sentiment in the main economic regions – were rather resilient. On the side, Russia and China were affected by increased geopolitical tensions with the West. This led to very dispersed performances from emerging market managers depending on their fund’s positioning. We think that emerging markets continue to offer a wide range of investment opportunities across asset classes (currency, interest-rate curve, single name equity and debt) but will continue to closely monitor them.
March was a difficult month for event strategies, due to falling equity markets, widening deal spreads and increased geopolitical tensions. Nevertheless, despite strong market shocks, these strategies were, on average, rather resilient, managing to end the first quarter close to flat. Nonetheless, the opportunity set remains intact, with a healthy number of deals having been announced since the start of the year.
The equity market sell-off and general deal spread-widening, coupled with a strong global deal flow, currently makes merger arbitrage an attractive opportunity set.
We are closely monitoring distressed managers, due to the potential of 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. Nonetheless, there have been some cracks in the painting, where the market or banks have punished severely highly levered companies that did not deliver on their promises or seemed too stretched to be viable. 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, seriously affected by technology innovations, offer plenty of dislocations within the sector.
The quest for yield has been challenged for the first time since February 2016. If long-only credit products have suffered, the recent spike in volatility has also created a significant sell-off of the basis, allowing relative value managers to capitalize on the regime change.