Capital markets concluded 2016 on strong gains across equities, the US Dollar and energy commodities. This price action was fueled by optimism regarding US growth anticipations for 2017. This optimism contributed to driving US rates with longer-dated maturities higher. In Europe, equities posted significant gains in Italy, France, Germany and Spain as well as in Russia. European yields also rose. The US dollar continued to gain against the Euro, the Yen and the British Pound. Oil and Gas gained in December again. Against this background the HFRX Global Hedge Fund Index in EUR posted a 0.64% gain with strong a positive contribution from directional strategies.
We are neutral on the strategy due to the unstable correlation among factors and heavy sector rotation. The recent renormalization benefited our selection of L/S market-neutral managers. We believe that fundamentals will pay back now that political decisions and fundamentals will play a more influential role than central-bank intervention.
Over the past month, stock markets in advanced countries strengthened further, spurred by expectations of fiscal stimulus and deregulation in the US and by solid incoming data. In 2017 markets will see whether this optimism is justified as president Trump takes office. Many political and economic uncertainties remain (elections in Europe, credit in China…). As mentioned last month, we believe significant shifts in asset prices will continue to occur as anticipations adjust to realities. The macro strategy will be able to capture and benefit from these wide market moves.
We continue to favour short-term managers that may benefit from increasing trading flows and volatility as global investors will need to shift their portfolio allocation to adjust to the changing macroeconomic conditions (as mentioned above in the macro section). And we continue to avoid the slower strategies, which have become crowded due to their success in recent years. 2016 was a difficult year for quant managers, with low volatility, heavy sector rotation and short-covering, but over the long run quant strategies have been the best and most consistent performers, we remain oervweight in these strategies.
We are increasing our fixed income arbitrage allocation. The recent US election and the forthcoming elections in several European countries have increased volatility on interest rates; this will benefit the strategy. Our managers are benefiting from European basis trading and the widening of US swap spreads in the run-up to the money market reform. There are fewer opportunities on the JPY RV side.
Emerging markets offer plenty of investment opportunities, across asset classes (currency, interest rate curve, single name equity and debt). To exploit these opportunities, we have invested in global macro managers, some specialized in a given region like Asia, and in local managers that carry out fundamental analysis and on-site company visits to pick stocks.
While we believe that this strategy continues to make sense, its net long bias nevertheless puts it at risk in the event of strong market turbulence. Even if risk/reward is proving less profitable now than in recent years, our managers posted strong returns in Q3 2016.
The investments in European event managers that we are exploring will benefit from the need to bolt-on growth.
In M&A arbitrage, we favour less static and more spread-trading-oriented managers, as average margins among deals have compressed significantly.
We are more bullish on the distressed cycle, because of the potential increase in interest rates and the reduction in QE. So far, the energy sector, in which there has been massive issuance in recent years, has provided an attractive pool of opportunities, given the volatility of oil prices and its impact on these securities. Emerging markets may also offer opportunities due to the strength of the dollar and the hike in interest rates.
We remain cautious on the strategy, although the US market has been more challenging than Europe. The quest for yield and the zero-to-negative rate environment have provided strong support for the asset class, and delivering performance on the short side is highly challenging.