Buffeted by the Correction
- Choppy equity markets have brought a spike in correlations, meaning near-term headwinds for Long/Short Equity. Move back to Neutral.
- Attractive opportunities for Event Driven funds to take advantage of Special Situations created by corporate restructuring and Merger activity. Stay Overweight.
- Spreads have yet to widen enough to boost the return potential for Credit Arbitrage. Low defaults mean few opportunities for Distressed Debt. Still Underweight.
- CTAs have cut exposure on the momentum reversal. Global Macro funds may struggle given central bank dominance in many markets. Neutral, including for Commodity-Trading Advisors (CTAs).
Market Neutral funds more attractive now
"Higher volatility has enabled market-neutral funds to reduce leverage, making them less risky, and inter- stock dispersion should recover in due course."
- Long/Short Equity. The sharp reversal in equity markets last quarter proved challenging for long/short managers – as often during corrections, stocks moved lower in sync, making it more difficult to offset losers with gainers. Such periods tend to last a few months as traders adapt to the new environment, and so we expect only modest returns, with higher volatility, this quarter. On the other hand, the strong macro backdrop should help boost earnings growth, as will cuts to US corporate tax. In this context, managers with a strong focus on deeply undervalued opportunities should do well. Market Neutral funds now look more attractive – higher volatility has enabled them to reduce leverage, making them less risky, and inter-stock dispersion should recover in due course.
- Event Driven. The equity sell-off also hit Special Situations strategies. There are many opportunities emerging as companies push through changes in their capital structure and business mix, but the return potential will only be unlocked gradually. In Merger Arbitrage, deal flow will be boosted in the US as tax rates fall and overseas earnings are repatriated and may be put to work in M&A. In recent weeks, the White House blocked the Broadcom/Qualcomm merger – such interventions are likely to increase deal spreads and hence return potential as traders seek compensation for heightened uncertainty. This is also still the best source of diversified returns in Hedge Funds.
CTAs are struggling
"CTAs are unlikely to benefit from any rallies as they will take time to identify new trends and rebuild positions."
- Credit/Distressed Debt. Credit spreads have risen modestly from historically-low levels in sympathy with the choppy trading in equities. However, the move has not been sufficient to restore lasting return potential for Credit Arbitrage strategies. In addition, passive Exchange-Traded Funds of high yield bonds have begun to see outflows in recent months, bringing indiscriminate selling pressure to the segment. The solid macro backdrop is keeping default rates historically low, leaving slim pickings for Distressed Debt managers. There are still more attractive opportunities in other Hedge Fund strategies.
- Global Macro/CTAs. Trend-following managers – known as CTAs – have been hit by the reversal in stock markets in recent months, and their trading rules have dictated a cut in exposure to equities. This means that CTAs are unlikely to benefit from any rallies as they will take time to identify new trends and rebuild positions. Global Macro strategies still face challenging conditions. Many markets have become dominated by central bank asset purchases, and hence trade less on fundamentals. In addition, shifts in the currency market have become less dependent on differentials in rates, making FX more difficult to trade on macro fundamentals.
Sources: SGPB, Bloomberg, 29/03/2018. Past performance should not be seen as an indication of future performance. Investments may be subject to market fluctuations, and the price and value of investments and the income derived from them can go down as well as up. Your capital may be at risk and you may not get back the amount you invest.