Despite being a holiday period, August was an action-packed month! The promise of an additional 10% tariff on $300 billion of Chinese imports was one such action that triggered a market correction. However, Alberto Fernandez’s surprising but unequivocal win in the Argentinian primary elections was certainly one of the month’s most painful market events. Once again, central bankers were called frontstage to put out the fire.
Almost every equity market in the world finished August in the red. Unsurprisingly, the Argentina Merval Index lost almost half its value (-41.49%) during the period, pricing in hard times to come. The Hang Seng Index – affected by both world trade disruption and local political unrest – lost -7.39%. On average, European and US equity indices declined between 1% and 3%. Defensive and quality stocks outperformed, widening the spread to value and cyclicals.
In terms of mid-to-long-term maturities, yield curves from the main economic regions moved down to adjust for deteriorating growth and below-target inflation expectations. US treasuries rallied by around 40 bps for maturities over 2 years. Euro issues rallied to a similar extent. Investors are hesitant to short these rich bonds because, even though expensive, they could become more expensive. Following the elections, investors priced in a sovereign debt default leading to Argentinian bond prices crashing and yields skyrocketing.
On average, commodities sold off during the month, apart from some exceptions like precious metals, palm oil and natural gas. As investors fear that rebooting monetary QE programmes will erode currency values, gold is making its way into a lot of portfolios, gaining close to 7% during the month.
The HFRX Global Hedge Fund EUR was flat +0.02% during the month.
Long short equity indices were, on average, negative during the month of August. Losses were moderate, considering managers were keeping their net exposures low. Market-neutral strategies were positive. This was particularly the case for stock-pickers with a fundamental quality bias. The flight-to-quality move contributed to widen further the spread between quality stocks and cheap cyclicals. Year-to-date, this strategy continues to perform well. The current environment is not easy, due to economic uncertainty and rapid sentiment changes. However, strong dislocations always create opportunities for either long or short investments. This strategy offers a wide range of levers that can be used to benefit from industry restructurings and sector dispersion from a long or short perspective.
It was a strong month for both discretionary and systematic global macro strategies. Gains were made mainly on long bond positions but also on long precious metals investments and long USD currency trades. Global macro managers with a Latin America book were, on average, long Argentinian sovereign bonds in local and hard currency. These positions detracted from performance. The significant victory of left-winger Alberto Fernandez took the market by surprise. The primary election poll results were pointing towards a slight advance for the left wing rather than a 15% gap between it and current president Mauricio Macri. In this environment, we would tend to favour discretionary opportunistic managers that stay on the sidelines looking for asset price dislocations. These managers can use their analytical skill and experience to generate profits from a few strong opportunities worldwide.
August was positive for Quant strategies. CTAs continued to benefit from strong trends in fixed income, commodities and currencies. Multistrategy quantitative managers’ results were mixed, due to the negative impact on performance from some equity statistical arbitrage models.
The strategy is still benefiting from a much better opportunity set than last year in the US (the basis in the US is twice as wide as last year), as well as opportunities in Europe, e.g., France, Italy. The new LTRO programme and the Fed’s dovish tone are likely to sustain ongoing swap-spread widening and create dislocations. On the short part of the curve, the YTD tightening of the OIS Libor basis has benefited some funds. It is important to highlight that funding and access to repos is one of the pillars of the strategy and that access to bank balance sheets has become more challenging. Since the beginning of the year, all managers in this space have delivered strong risk-adjusted returns, while being positively exposed to volatility.
Emerging markets were under the spotlight during August. While long investments in Argentina were causing a lot of pain to Emerging Market managers with a Latin America bias, the picture was brighter in other regions of the world. Investors continue to see value in Brazil, Russia and, to a lesser extent, Turkey. Managers are concerned by the negative impact on fundamentals of global growth slowing and international trade disruptions. However, the future easing path of US dollar interest rates is a positive factor, specifically for EM countries relying on US dollar debt issuance. It has not an easy environment for EM strategies. Nevertheless, there are strong dislocation-generating opportunities for seasoned opportunistic managers.
August’s performance for Event-Driven indices was muted. Merger arbitrage deals in terms of value and volume for 2019 sit below 2018’s figures, which is comprehensible considering the current macro uncertainty. However, managers are, on average, optimistic about the outlook for Risk Arbitrage due to a supportive business environment with benign financing conditions, and the willingness of corporate management teams to fight for sources of business growth. Also, spreads for large deals are currently at interesting levels due to increased complexity in the approval process, specifically in the US. It is also interesting to note that the increase in shareholder activism challenging announced deals is also helping keep spreads wider.
The 2019 risk-on environment reversed most of the spread-widenings seen in Q4 2018. Distressed and stressed strategies are currently tending to overweight their portfolios with hard-catalyst investment opportunities, which are diminishing the negative impact of beta. Managers are raising cash levels for dry powder with which 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.
Despite some more volatility, spreads – supported by the chase for yield – are still heading in the same direction. Hence we remain underweight, as there is limited-to-no-comfort in being short the credit market, where there is strong demand and the negative cost of carry is quite expensive.