Omicron is coming to town. The uncertainty around the impact of a new COVID-19 variant on our lives caused some tough market sessions in late November, with investors bringing back their 2020 playbook. Market direction is uncertain and nervous, which is understandable considering the number of moving pieces of important data points relating to infection rates, inflation rates and growth projections.
Equity markets declined sharply going into the end of November, finishing the month with negative mid-single-digit returns. Spanish equities were among the negative outliers, returning slightly over -8%. Hong Kong and Korean equities also lagged, returning close to -5% and -7.5% respectively. Information Technology-heavy indices like the Nasdaq and Taiwanese equities outperformed, finishing the month slightly positive. Unsurprisingly, technology and consumer sectors outperformed cyclical sectors, benefiting from a strong earnings season and strong consumer data, but also remaining relatively immune to the impact of the new COVID-19 variant.
Sovereign yields on the front end of the curve were relatively volatile over the month. While US short-term rates increased slightly to reflect a more hawkish Fed stance, Euro rates rallied as Christine Lagarde did not indicate any rate hike in 2022 to counter the rise of inflation in Europe.
Energy-related futures suffered the most during the month, declining between 15% and 30%.
The HFRX Global Hedge Fund EUR returned -1.37% over the month.
On average, Long-Short Equity strategies were negative during the month. However, dispersion within the strategy is relatively important, as many stock pickers benefited from the earnings season to generate profits on both their long and short books. Strategies with low market directionality and strategies with a quality bias tended to outperform strategies with significant exposure to crowded names, unprofitable technology business models and cyclical sectors exposed to reopening the economy. Since the start of the year, Long-Short Equity funds have registered positive mid- to high- single-digit returns. On a relative basis, strategies with a focus on Asia outperformed their US and European peers, with very good upside capture ratios with respect to their regional equity benchmarks. We still believe that Long-Short Equity funds remain well positioned to benefit from both their long and short books, offering an interesting risk-reward ratio. They will benefit from increased intra-sector dispersion, while trying to capture with their short books the excess liquidity flowing into the markets and particularly dislocations in work-from-home beneficiaries.
Returns for Global Macro managers were very dispersed during the period, with average returns coming in slightly negative. In this volatile environment, discretionary managers tended to outperform systematic managers. Long positions in equities and commodities and short rates were the main performance detractors. We are currently seeing a progressive decoupling of monetary policies in some major economic regions. While China is trying to steer itself away from the heavy monetary stimulus of the past, the United States and Europe are approving massive investment plans, which will probably have a significant impact on their borrowing rates and currencies. Macro managers should be able to capitalise on these market moves. We continue to favour discretionary opportunistic managers who can draw on their analytical skills and experience to generate profits from selective opportunities worldwide.
The market reversal that took place in the second half of November had a negative impact on CTAs, as profits on currencies were negatively balanced by losses on equities, rates and commodities. Multi-strategy quantitative managers managed to smooth the negative impact of trend models, benefiting from higher volatility levels in arbitrage models. Since the start of the year, Quantitative strategies have managed to benefit from strong asset trends and from market volatility to print decent performance figures.
Fixed Income Arbitrage
The rhetoric around tapering, mixed with the revival of inflation fears triggered by skyrocketing energy prices and the sudden change in the Fed rhetoric, resulted in a brutal and painful awakening of the fixed income space. Similar to the moves managers experienced in May 2021, the spike in interest rates triggered a flattening of the US yield curve. Although the directional move towards higher rates on the shorter end of the yield curve (up to the 7-year mark) was quite straightforward, the behaviour of the long end of the curve was less dynamic. If this move is at the heart of one of the most sanguine moves for the strategy due to the steepening consensus trade, it is worth highlighting that our managers proved quite resilient.
During November, Emerging Markets correlated with the downward trend of the markets. EM strategies, which tend to have a higher net long directional bias, were on average negative for the month. Investments in rates and currencies have not been great performance drivers for fundamental managers this year. High commodity prices have been a positive tailwind, helping EM countries rich in natural resources repair their balance sheets. We are cautious on the region. COVID-19 infection rates remain a source of instability for global trade, but also political narratives from developed nations are becoming more nationalistic and inward-looking, which may put direct investments in the region necessary for their economic development at risk. Considering the fragility of fundamentals, we prefer fundamental managers that adopt selective investment approaches.
Risk arbitrage – Event-driven
Overall, event-driven strategies did not take part in the risk-off move, and were flat for the month. Strategies with a higher allocation to special situations underperformed pure merger arbitrage strategies due to their directional equity component. The Biden administration’s nominations to the FTC and DoJ have increased uncertainty on deals closing. This will probably lead to a smaller volume of deals and a longer duration for them to close, but it will also help maintain wider spreads and avoid the strategy becoming overcrowded. There is an element of cyclicality that is structural to this industry, but the impact of COVID-19 and industries undergoing structural transformation will generate further corporate actions, giving managers opportunities to deploy capital. With investors currently looking for diversification, merger arbitrage provides an interesting tool that is structurally short-duration, where deal spreads are positively correlated to increases in interest rates.
For the moment, the environment is relatively calm for distressed strategies. The volatility seen in sovereign yields has not yet spilled over into corporate spreads, apart from specific situations. Year-to-date, performances for the strategy have been positive. They were mainly driven by stressed investment opportunities occurring after the COVID-19 crisis in 2020 and by high energy prices that helped heal the balance sheets of a sector that is often affected by commodity price volatility, and also by continued liquidity support from central banks. The opportunity set for the strategy remains modest or limited to specific sectors. Nonetheless, we remain attentive because, as central banks initiate tapering and rates start to rise, this strategy might become more attractive. We favour experienced and diversified strategies, to avoid having to face extreme volatility swings.
Long/short credit & High yield
Following the market crash at the end of the first quarter of 2020, hedge funds have opportunistically loaded on IG and HY credit at very wide spreads. Managers who were able to go into offensive mode aggressively bought on the market or made off-market block trades, whereas other managers, unable to meet margin calls, needed to quickly cut risk. Since then, spreads have completely reversed back to pre-COVID levels. Multi-strategy managers have significantly reduced exposure to credit and high yield, as current valuations present limited expected gains and a negative risk-return asymmetry.