January was a very eventful month. The first half of the month saw a continuation of December’s move, with investors buying US small and medium-cap stocks and continuing to increase their allocations into cyclical assets. Not even the attacks at the US Capitol managed to derail the trend. Markets took a turn for the worse during the second half of the month, when the GameStop short squeeze hit the headlines, causing significant losses to a couple of well-known and established hedge funds.
Equity index returns were strongly dispersed in January. Asia and small/mid-cap US equity indices outperformed, returning mid-to-high single-digit returns. At the other end of the spectrum, Europe and Latin America indices declined to mid-to-low single-digit returns during the period, with the deployment of the vaccination programmes delayed due to insufficient vaccine supply. Sector-wise, energy stocks were among the best performers, with the prospect of progressing to a “normal life” and a controlled oil supply supportive of commodity prices.
Government yields and corporate spreads remain close to all-time lows but massive liquidity injections are pushing inflation expectations and long-term rates up, specifically as regards US Treasury maturities of 10 years and more. Commodities had, on average, a strong month. The biggest increases – around 10% – relate to oil and corn.
The HFRX Global Hedge Fund EUR returned -0.24% during the month.
Long Short Equity
It was a very challenging month for Long Short Equity strategies, with retail investors taking interest in GameStop, a video games retail business that’s in relatively bad shape. This was the beginning of a traumatic experience for some Long Short Equity funds. Retail investor flows pushed GameStop’s stock price up, causing losses on short sellers, who then had to cover their short positions by pushing the stock price even higher. After it was known that an established manager had printed high losses on the trade and received an emergency cash injection, many hedge funds cautiously de-levered to avoid a similar predicament. The combined de-risking of funds selling longs and covering shorts had a negative impact on performance, with managers losing their month-to-date gains. The positive side of this event is that it allowed the market to let off some steam, reminding it of the importance of carefully selecting and sizing its short positions. Long Short Equity remains an interesting investment opportunity for 2021. During last year’s market rebound, intra-sector correlations and cross-sector dispersion were high, generating many relative-value opportunities. Furthermore, managers can deploy capital into long and short investments across sectors undergoing a major reshuffling, like media, retail, mobility and energy. Long Short Equity as a strategy, very rich and diverse in terms of thematics and styles, possesses several tools to face different market environments.
Once again, discretionary macro managers outperformed, on average, systematic macro strategies. Performance across the space was dispersed, depending on the fund’s area of focus. Long positions in commodities contributed positively, with gains coming from oil and industrial metals. Short US long-term rates anticipating higher inflation and a steepening of the yield curve were also additive to performance. Short positions in US equities suffered from the late-January short squeeze. We continue to favour discretionary opportunistic managers capable of drawing on their analytical skills and experience to generate profits from selective opportunities worldwide.
Whereas January was relatively poor for quantitative strategies, Multi-model strategies managed to pull off a decent month. Trend-following models were, on average, flat, with the gains from commodities and equities balanced by losses on rates and foreign exchange. Those Equity Market Neutral statistical arbitrage strategies that printed the poorest returns directly affected the massive market de-leveraging in late January. Quantitative strategies remain in a rough path. Considering that quantitative funds draw their edge from analysing huge volumes of past data points in order to define the strategy’s current positioning, they are understandably having difficulties dealing with a totally unchartered economic environment. Short-term trend-followers were a small subset of funds that managed to benefit from the different market phases, making money from the strong up-and-down market moves. Sophisticated multi-strategy quantitative funds also benefited from increased market volatility levels to generate interesting returns. Nonetheless, investors were, overall, disappointed with quantitative fund performances throughout the year, as most algorithms had difficulties dealing with the violent and rapid increase in market volatility and asset correlations.
Fixed Income Arbitrage
Since March 2020 and its historical level of dislocation, volatility across G3 interest rates has collapsed, on the back of clear central bank rhetoric encouraging stability to fight the pandemic-triggered economic slowdown. There have hence been fewer opportunities in that field for the last six months. However, the “low-rate environment” offers a very compelling opportunity if, with the help of the vaccine, US growth were to accelerate and the situation to normalize. Since December, the yield curve has steepened and swap spreads have widened, helped by higher US yields and changes in market dynamics, making US bonds cheaper than futures and increasing the strategy’s opportunity set. In Europe, the poor level of issuance has had the reverse effect (bonds are more expensive than futures) while swap spreads have also widened. These recent changes in terms of positioning and potential inflation fears have clearly improved the strategy’s ecosystem.
Prospects of a continuing economic recovery and a weak dollar are strong factors supporting Emerging Market asset valuations. With a significant part of the global bond market in negative-yield territory, Emerging Markets are an appealing investing ground for investors seeking decent fixed income assets. EM credit should also benefit from higher commodity prices. Although EM yields are at historically low levels, EM government and corporate spreads versus Developed Market issues are above historical averages. Some analysts believe that low Treasury rates and greater political stability in the US will continue to make investors seek higher yields in Emerging Markets. Although the macro outlook remains extremely foggy for Emerging Markets, fundamental managers consider it an interesting option in a zero-rate world where, considering the fragility of fundamentals, these managers usually adopt a very selective approach. Caution is required, due to the higher sensitivity of the asset class to investor flows and liquidity.
Risk arbitrage – Event-driven
January was a good month for Event Driven strategies. Most managers were relatively immune to the late-January market reversal. On average, merger deals contributed positively, with spreads going in the right direction. One of the biggest contributors was Cisco’s increased offer for Acacia Communications. SPACs are becoming an important source of opportunities. According to one of our managers, the value of new IPOs in January 2021 represented 25% of 2020 total issuance. Merger deal activity is expected to continue in the near future. Interest rates are low, and corporations, cutting costs, have issued debt and equity to face the crisis, but also to be ready to snap up strategic assets. Activity is being driven by the need to restructure in stressed sectors like energy and travel, the willingness for consolidation in healthcare, financials and telecom, and the need to adapt to today’s new reality by externally acquiring technologies that would take too much time or money to develop, such as in the semiconductor space.
Stressed and distressed strategies made a good start to the year. As the prospects of the economy reopening improve, troubled assets are benefiting from the latest wave of asset repricing. It is interesting to note that, in 2020, many distressed managers had above-average portfolio turnover levels. As the market dropped at the end of Q1, all assets – irrespective of quality – crashed . The most successful managers were able to provide liquidity by buying discounted quality assets. As the year progressed, they sold those positions at a profit to move into more stressed assets. As these assets have repriced significantly with the vaccine release news, some are starting to take profits, buying the more valuable parts of the distressed market that will be able to profit from the reopening of the economy. That is the status as we enter 2021. We favour experienced and diversified strategies to avoid having to face extreme volatility swings. It is not going to be easy but this is the environment and opportunity set these managers have been waiting for this last decade.
Long short credit & High yield
Credit spreads for Investment-Grade and High-Yield markets reached 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. Investment-grade and quality high-yield spreads in the US and Europe are now close to pre-COVID levels. News relating to the high level of efficacy of the Pfizer/BioNTech and Moderna vaccines pushed credit spreads even lower, leading to an outperformance of riskier issues. Although the beta trade is behind us, we think that long-short credit offers interesting opportunities, on both long and short, to capture fundamental inconsistencies triggered by this year’s strong dislocations.