Trade-war threats were one of the main elements influencing market sentiment during the month. Investors are closely following negotiations between the Trump administration and its major trade partners. However, with this president, that’s a task and a half. The world economy is still in a good place but more warning signals that we might be shifting into a new phase of the economic cycle are emerging.
Equity market performance was dispersed during the month. European equities outperformed the other regions, helped by the weakness of the Euro, each country index returning between 4 and 6%. Japanese equities also had a strong month, whereas Taiwanese stocks suffered due to the weight of semis. Argentina’s Merval Index lost close to 5% following the anticipation of monetary adjustments. Despite the macroeconomic disappointments, equities held up well due to a good earnings season. The energy sector – benefiting from rising oil prices – outperformed.
Being short US treasuries seems to have replaced being long equities as the new momentum trade. The US 10-year is anchored around 3%. This, coupled with a strong dollar, has put some tension on Emerging Market countries with high levels of US-denominated debt. Also, treasuries are becoming a more attractive alternative to equity dividend yields. On the currency side, the dollar gained around 1 to 3% versus the major world currencies. The WTI had reached $68 by the end of April. Investors were concerned that the political tensions surrounding Venezuela and Iran might affect the commodity supply.
The HFRX Global Hedge Fund EUR index was down -0.17%.
Equity indices, supported by a good earnings season, rebounded in April. Nevertheless, long/short equity funds seem to be selling the rallies rather than buying the dips. Overall, gross exposures have been decreasing. YTD, long/short total alpha remains positive but it has come off its highs. Performance dispersion was high, the highest among hedge fund strategies. Although the earnings season was good, equities are no longer quite flavour of the month. Treasuries have started to offer a credible alternative to dividend yields, trade-war threats are still in the air and the Eurozone economy has stopped accelerating.
Nonetheless, long/short equity managers are an interesting investment proposal because they have more tools 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.
Our global macro strategy offers a wide range of investment possibilities that, in theory, should benefit from the current asset risk repricing. 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 the widening in credit spreads. Macro strategies will be able to capture and benefit from these wide market moves. April was mostly beneficial for macro, with strategies benefiting from long investments in oil and short US Treasury bets. Funds with an Emerging Market bias had a tough time dealing with market movements in Argentina, Turkey and Russia.
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 April.
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 the potential economic slowdown generating significant volatility on both swap spreads and on the futures basis, generating significant opportunities.
If access to balance-sheet lines in the US hadn’t been a problem till year-end, the first quarter was the Libor/OIS spread reaching historically high levels due to heavy Treasury issuance that 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 tightened.
YTD, all managers in that space delivered strong risk-adjusted returns while positively exposed to volatility.
Emerging Market performance continues to be very dispersed. Latin America, apart from Argentina, remains resilient, with the Chilean, Brazilian and Mexican equity indices posting nice returns. Russian assets suffered from the sanctions imposed by the US. Commodities like aluminium, on the other hand, gained more than 10% following the sanctions imposed on Rusal.
Although 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), we will continue to closely monitor them.
Our event-driven performance was challenging during the month but overall positive. Some merger arbitrage deal approvals seem to have been used as a retaliation measure to Donald Trump’s tariffs. This led to most deal spreads widening. Considering that there is still a strong global deal flow, this 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 are offering a negative risk asymmetry. High yield saw important outflows and spreads widening after February’s sell-off but the trend has reversed. April again saw net inflows into the asset class and spreads tightening by 30 bps.
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 created a significant sell-off of the basis, allowing relative value managers to capitalize on the regime change.