19 MAR


Absolute Return , Topics

The market without a playbook

Financial markets began the month on the same positive note as early January, until the European coronavirus outbreak looked more serious than previously anticipated, with Italy being the most affected country. Market optimism was replaced by uncertainty as investors struggled to grasp how fast the virus was spreading, amid fears of a major economic worldwide shock.

Most equity indices plunged and erased months of positive performance in just a few days. The MSCI Europe finished the month down 8.7% and the S&P 500 returned -8.41% over the same period.

While investors were waiting for government intervention to stop the crash and boost the economy, US 10-year treasury yields hit a new record low, amid a mass flight to quality.

Commodities were also hit hard, as most futures prices accompanied the risk-off movement. Oil plunged 13%, anticipating a massive drop in demand.

The HFRX Global Hedge Fund EUR fell 1.75% over the month.


Long short equity

LS funds struggled at the end of February, losing almost 3% gross on average during the last week of the month, reducing gross MTD returns to -2%. However, despite the S&P index sliding deeply into the red, the downturn did not scare hedge funds as they were fairly large net buyers of US equities.

According to prime broker data, Europe-focused funds underperformed strategies investing in US and Asian markets as Europe was struck by the coronavirus. European LS equity managers returned -3.04% on average during February, followed by US LS funds, which returned -1.94%, while Asian LS funds were up 0.94% on average. During the last week of the month, US LS funds saw a drop in average gross exposure of 8% WoW, to 190%, and average net exposure falling 7% WoW, to 44%. European average gross leverage fell 4% WoW to 210% and average net exposure fell 1% WoW to 34%, while Asian gross was stable.

Notably, during the last week of the month, the 50 most common US long investments were down 11% WTD, but the 50 heaviest short positions did not fully offset these losses, falling by only 9% and representing a long vs short spread of -2%. The market will remain challenging until it stabilises or finds a bottom. However, fund managers can protect capital by reducing their net exposure and make gains on their short books. A well-balanced portfolio of long and short investment opportunities may be more resilient to a difficult market environment.


Global Macro

February was a challenging month for global macro strategies, as few investors had factored in such a rapid spread of the virus across the world. After the market reacted negatively to the announcement of the Chinese epidemic outbreak towards the end of January, it recovered sharply, supported by strong corporate earnings and improving economic data. The potential negative impact on economic output caused by disruption due to the virus came as a major blow for many fund managers. Fund returns, although negative on average, were nonetheless dispersed due to varied portfolio positioning. Considering the high volatility levels and future uncertainty, fund managers are focused on reassessing current positions and reducing risk, while awaiting the announcement of government support plans before increasing portfolio risk. Before the coronavirus, Asia and Latin America seemed to be gathering some consensus among investors as investment opportunities for 2020. Until the current health crisis is contained and dealt with, outlook is less clear however. In this environment, we would tend to favour discretionary opportunistic fund managers who can draw on their analytical skills and experience to generate profits from a few strong opportunities worldwide.


Quant strategies

Short term trend following models posted healthy returns during the month, quickly shifting from long to short equity index positions and remaining long of bonds. Sudden market reversals and increasing correlations were not favourable for longer term quantitative models and statistical arbitrage strategies however. Breakout models continued to outperform during the month of February. Although advances in technology have helped democratise access to quant management, the rising costs of data, talent and business set-up, have made it very difficult to enter the elite winning circle.


Fixed Income Arbitrage

In line with most other markets, the FI segment adopted a risk-off profile during February due to concerns over the coronavirus weighing on global growth. The US yield curve bull-flattened as investors fled to safe haven assets and volatility surged across all maturities. As the pace of the trend increased, the basis between the cheapest to deliver securities and futures widened slightly, along with the OIS vs Libor basis spread.


Emerging markets

Dispersion was high among emerging macro fund managers, depending on positioning and focus region. Falling energy prices and supply chain issues were the main disrupting factors during February. However, EM strategies proved relatively resilient on average during the first risk-off wave. Currently, the broader picture nonetheless depicts higher than ever levels of uncertainty. Although we are seeing sharp dislocation that will generate opportunities within this strategy, we will have to wait for the dust to settle before there will be any improvement in terms of clarity.


Risk arbitrage - Event-driven

During a highly challenging month, risk arbitrage strategies posted slightly negative performances during February, proving resilient to the overall equity market trend. Negative p&l generated by long special situation investments were compensated by market hedges, while merger arbitrage deals contributed negatively to performances as spreads widened. In spite of the turbulent markets, several new M&A deals were launched, with acquirers taking the opportunity to buy target companies at lower prices.



Distressed strategies did not perform well last year. Returns were negatively impacted by specific situations like the bankruptcy of PG&E and also by investors’ reluctance to bid for complex situations during times of high uncertainty. The 2019 recovery was accompanied by deteriorating sponsorship in the more complex segments of the credit spectrum. CCC bonds in the US are now trading above a 1,000bp spread. Should corporate bond default rates begin to rise over the next 2 years, credit risk could be expected to be repriced across the entire spectrum. Fund managers are raising cash levels to keep their powder dry, waiting to reload portfolios with any new issues pitched in the distressed market. Although we are closely monitoring distressed fund managers, due to their high potential expected returns, we are remaining broadly on the side-lines.


Long short credit & High Yield

Despite an upsurge in volatility, spreads remained tight, supported by the chase for yield. We therefore remain underweight as short credit market positions harbour inadequate potential upside, as there is strong demand and the negative carry costs are expensive.