22 JAN

2020

Absolute Return , Topics

The never-ending Bull Market…

Last year, financial markets generated another year of very strong returns. Consensus among investors is of the opinion that it will be hard to beat last year’s returns in 2020. It would be difficult to think otherwise. We are at the late stages of one the longest expansion cycles in history, valuations are stretched and the threats to economic growth have yet to be resolved.

December was very strong for equity markets, with almost all the main indices generating low-to-mid-single-digit positive returns. China, Hong Kong and Taiwan, benefiting from positive developments in the trade-deal discussions, outperformed. The Argentina Merval Index was up more than 20%, following the government’s initial decisions.

Long-term sovereign yields were stable-to-slightly-up during the month. The Riksbank’s decision to end its negative-rate policy was perhaps one of the moves during December that most stood out.

The last month of the year saw, on average, commodity prices appreciate. Palm-oil futures increased by around 16%, finishing the year up more than 50%. Contracts on coal and natural gas declined slightly during the month, declining during the year by -33.66% and -25.54% respectively.

The HFRX Global Hedge Fund EUR climbed +0.65% during the month.

 

Long short equity

December was a good month for the strategy, which benefited from benign equity market environments. Obviously, net long bias strategies had a favourable tailwind compared to market-neutral strategies, which tend to suffer from strong trendy markets. According to the Morgan Stanley Prime Brokerage report, the year-to-date average performance for the strategy is 11%. US focus strategies have, on average, outperformed European- and Asian-focused funds, returning an excess return of 3%. 2019 was the best year of alpha generation in the last decade. Nevertheless, Long Short Equity strategies’ upside capture ratio was around 50%. This relatively modest figure was justified by the defensive positioning of funds with lower net and gross exposures. In December, Asia Long Short funds – benefiting from advances in the trade talks between China and the US administration to catch up in terms of performance – outperformed their US and European peers. The current environment is not easy, due to economic uncertainty and rapid sentiment changes. During 2019, equity index performance was driven mainly by stock rerating. Picking the right earnings streams will play an important role in generating decent performances. However, strong dislocations always create opportunities for either long or short investments. American equities in the healthcare sector is a good example of this. It would be a mistake to shun the sector as a whole due to politically driven volatility. Good managers will benefit from the current situation to build a balanced portfolio of long and short investment opportunities. This strategy offers a wide range of levers that, from a long or short perspective, can be used to benefit from industry restructurings and sector dispersion.

 

Global Macro

Macro strategies had a decent December in terms of performance, specifically discretionary macro managers, who made money on equities and foreign exchange moves. On average, strategies with a focus on developed markets outperformed other subsets of the strategy. Asia and Latin America remain choppy markets but seem to be gathering some consensus among investors as an opportunity to invest in 2020. With developed market rates pointing downwards, EM high-yielding assets are starting to become somewhat desirable again. In this environment, we would tend to favour discretionary opportunistic managers currently on the sidelines awaiting asset price dislocations. These managers can use their analytical skill and experience to generate profits from a few strong opportunities worldwide.

 

Quant strategies

CTA strategies averaged negative returns during December, with strategies balancing gains on equities with losses on long dollar currencies and long bond bets. Systematic Equity Market Neutral strategies, probably affected by increasing correlations in a risk-on environment, also posted disappointing returns during the period. Despite late factor reversals, the correlation between momentum, low volatility and quality versus value factors remains at extreme levels. Continuing further reversal periods are not to be excluded.

 

Fixed Income Arbitrage

Central banks have made a clear pause on their dovish interest rate policy, which triggered a strong reversal both in the US and European rate markets after a very strong bond rally. After a subdued return in November, our managers were able to capture the seasonal spike in volatility due to year-end balance-sheet management, posting strong returns. EURUSD cross-currency swaps once more rocketed, OIS LIBOR swaps widened and our managers were able to capitalize on basis trading. We remain positive on the strategy, as balance-sheet issues and dollar scarcity mixed with a stellar budget deficit will, with no doubt, generate dislocations in the fixed income RV space.

 

Emerging markets

The Emerging Markets region is recovering from previous losses and benefiting from improving investor sentiment on relative value analysis. The big picture still presents high levels of uncertainty, however, in a sluggish growth environment, EM assets remain interesting opportunities for investors hungry for yield. Furthermore, declining US rates are kicking the problem of dollarized debt EM economies down the road. Argentina will be closely followed as a future indicator for the country and of the EM region as an attractive investment proposition. It has not been an easy environment for EM strategies. Nevertheless, there are strong dislocation-generating opportunities for seasoned opportunistic managers.

 

Risk arbitrage - Event-driven

December was a good month for Event strategies. Merger Arbitrage books – driven by tightening spreads and the successful close of significant deals like the acquisition of Celgene by Bristol-Myers for USD 74 billion – were, on average, positive. 2019 had a sustained level of large deals (over $20 billion), making it a solid year in terms of deals. We are optimistic about the opportunities 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 the increased complexity of 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 to keep spreads wider. Finally, in countries like Japan, some managers are pointing out that corporate governance initiatives have led to several significant cross-shareholder unwinds over the past few months.

 

Distressed

Distressed strategies have not performed well this year. Performances have been impacted by idiosyncratic situations like the bankruptcy of PG&E and by investors’ reluctance to bid for complex situations during times of high uncertainty. The 2019 recovery was accompanied by a deterioration of sponsorship in the more complicated parts of the credit spectrum. CCC bonds in the US are now trading above a 1000bp spread. Should corporate bond default rates begin to rise over the next 2 years, one could expect a repricing of credit risk across the whole credit spectrum. Managers are raising cash levels to keep dry powder, waiting to reload the portfolio with any new issues that hit the distressed market. We are closely monitoring distressed managers, due to the potential of high expected returns, but remain broadly on the sidelines.

 

Long short credit & High Yield

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.