A spark of optimism to start the year

The deconstruction of the World’s globalized logistic machine initiated by the Trump administration is flowing to the hard data. Worldwide, economic fundamentals and growth are deteriorating and there are many reasons that could explain it. Presently, investors do not have a better visibility than a month ago but, risky assets rebounded  strongly during the month following encouraging trade talks between China and the US, additional monetary stimulus in China and a dovish message to the markets from the Federal Reserve.

Equity indices rebounded strongly in January with cyclicals leading the way. In the US, biotech and small caps were up by low double digits. Argentinian stocks outperformed returning close to 20%. South Africa and India equity markets lagged due to political concerns while Taiwan was affected by disruptions on the semi-conductor chain. At the sector level, US industrials, energy and consumer discretionary segments were up by low double digits after a very difficult 2018.

Sovereign issues in developed markets slightly eased following dovish speeches from central banks. Short term Chinese bond yields declined by around 0.3% following a liquidity injection by the PBoC. US High Yield issues outperformed after an almost 100 bps premia compression during the month.

January was a strong month for commodities, which benefited from the risk-on environment. WTI gained +18.45% during the month and Palladium was up by 8.58%. This metal is important for the EV chain of production and saw its price more than double over the last 3 years.

The HFRX Global Hedge Fund EUR was up by 1.81% during the month.

Long short equity

It was a good month for long short managers. Investments in technology, healthcare, communication services and consumer discretionary which were heavily sold during Q4 2018, rebounded strongly in January 2019. Performance was mainly driven by the long book of the portfolio. Obviously, managers with a positive net long exposure had a nice tailwind from the markets. Gross exposures having increased, they are now close to historical averages. On the other side, directional strategies’ net exposure are still close to the low range and reflect a cautious approach by the managers to the current environment. Following the 2018’s sell-off, 2019 could offer an interesting opportunity for long short equity strategies. Even though, the year started with a strong rally, economic fundamentals are deteriorating and should expect a more range-bound market offering good opportunity picks for the long and short books.

Global Macro

Performance for global macro managers remains dispersed. Discretionary strategies tended to outperform systematic ones. Fundamentals are deteriorating but there are many unknowns in the air that could tip macro growth drivers up or down. After the statement of the Chaiman of the Federal Reserve and its effect on lowering market volatility, macro managers will closely track the economy’s health indicators to try anticipate the Fed’s next move. Global macro strategies tend to offer great opportunities in rising volatility environments, in periods of limited central bank intervention and when rates are rising.   

Quant strategies

Quantitative strategies managed to profit from the reversal of market dislocations of the last quarter. Trend following models were negatively affected by equity and commodity indices reversals. Statistical arbitrage strategies continued to generate interesting performances after November’s deleveraging event and the nice rebound in December.

Fixed Income Arbitrage

The dovish statement from the Federal Reserve Chairman, Jay Powell, seems to confirm the positive sentiment taking roots in Emerging Markets investors. Managers like the developments taking place in Brazil and Argentina which could positive returns in the short to medium term. Venezuela could offer interesting opportunities from a deep value perspective but considering the complexicity of situation, managers have only small positions in the country. While the timing of the resolution of most macro concerns is unknown, the dislocations created by Donald Trump’s policies will, at one stage, become opportunities.

Risk arbitrage - Event-driven

Event driven strategies performed well in January, mainly driven by the long bias special situations equity bucket. Contribution from merger arbitrage was more variable due to a deal break in the unsolicited offer from Husky Energy for MEG Energy. Deal activity was healthy in H1 18 but slowed down over the rest of the year due to, among other things, rising uncertainty. The slowdown in Q1 19 might continue to affect deals completitions due to the US government shutdown. Indeed, deals requiring regulatory approuval will see the process delayed due to Agencies closing their doors. The environment remains supportive, with moderate growth and a relatively low cost of debt. Also, dedicated merger arbitrage managers say that complex deals are offering decent remuneration for the risk. Even though many companies postponed decisions in H2 due to political uncertainties, sectors being disrupted by new technologies provide fertile ground for corporate activity. We remain wary of some headwinds to the strategy, as the increasing leverage of corporate balance sheets may lead to credit quality deterioration and deal breaks.

Distressed

We believe that we are in the late stages of the credit cycle. January’s risk-on environment reversed some of the spread widenings seen during the last quarter. Stressed and distressed strategies currently are tending to overweight their portfolios with hard catalyst investment opportunities diminishing the negative impact of beta. Managers are raising cash levels to have dry powder to reload the portfolio with the new issues hitting the distressed market. We are closely monitoring distressed managers, due to the potential of high expected returns, but remain broadly on the sidelines. We see a growing number of US hedge funds specializing in distressed assets starting to raise money in anticipation of the next economic downturn. 

Long short credit & High Yield 

During Q4 2018, High Yield had its worst quarter since Q3 2011 (US downgrade), since then the market has bounced back strongly, erasing in 3 weeks all the negative performance of Q4 2018. The dovish Fed speech has triggered tighter spreads, chase for yields, and the re-opening of new issuance. However, we remain underweight, as there is limited comfort in being short credit market as the negative cost of carry is quite expensive and liquidity far from granted.