23 GEN

2018

Absolute Return , Asset Class

In the goldilocks zone

The world is for the moment in a sweet spot not seen since just before the last financial crisis. Most major economies are growing simultaneously, unemployment is low or decreasing, and rates are low or expected to rise smoothly. Emerging markets seem, mostly, fundamentally stable with contained debt levels and supportive rising commodity prices. No one can see where the threats will emerge from but, eventually, the situation will turn around. Prepare for the worst and enjoy the Goldilocks era while it lasts!    

Equity markets performed overall well. The best-performing regions were those like Brazil and Argentina, whose economy was more dependent on rising commodity prices. European markets, even though supported by sound fundamentals, suffered slightly from the political instability in Spain and Germany. One of the exceptions was the FTSE 100, which was up around 5%, probably due to a breakthrough in the Brexit negotiations.

Rates remained largely unchanged, demonstrating that all the available information had been priced in. On the other hand, investors sold the dollar during the month, anticipating a continuation of the improved economic fundamentals in non-dollar economic zones, leading to tighter spread-to-dollar rates and growth expectations.

Base metals continued their upwards trend. Precious metals continued to be well bid for, due to the popularity of batteries. Cobalt was up 12.62%. WTI gained more than 5%.  

The HFRX Global Hedge Fund EUR index was up +0.45%.

Long short equity

In 2017, beta provided a good tailwind for equity strategies. On top of that, it was a very good year in terms of alpha generation for long / short equity managers. This led to alternative equity indices posting, on average, double-digit returns. Due to the strong market momentum, market neutral posted more measured returns, due to the underperformance of their short positions. Naturally, for short sellers, it was even harder to play ball. For sector-specific managers, technology specialists posted the strongest returns, whereas, at the other end of the spectrum, energy managers posted the least compelling returns.    

Considering the rich market valuations for all asset classes, volatility levels will probably increase in 2018. We are in a Goldilocks environment in which equities seem to offer the best expected returns over the near future, offering decent yields in a low-rate world and protection from a smooth rising-rates path. Nevertheless, there are many interesting thematics to be explored from a long / short equity angle. The new tax regime in the US will generate winners and losers. There are also more long-term structural transformations like those caused by technology behemoths within media and retail sectors that offer opportunities on both sides of the portfolio. Japanese corporate governance seems to be becoming more sensible about shareholder returns, offering good opportunities on the long side. On the short side, Chinese liquidity restrictions and the financial monitoring of leverage will, for sure, put many highly indebted companies under the spotlight. Also, European economic robustness and its relative valuation, i.e., cheapness, versus other assets make it a very compelling investment opportunity for the quarters to come. Some managers are expressing this by increasing their net exposures to European cyclicals at the expense of defensive stocks, considered to be priced for perfection. We think that long / short equity strategies still have many opportunities to offer in 2018.


Global Macro

Over the year, global macro managers’ performance was dispersed. The current transition phase of central bank support programmes has resulted in very heterogeneous fund positioning. In 2H, performance was mainly driven by equity markets and currency moves. On a more idiosyncratic basis, the hit ratio of discretionary managers’ trades was a mixed bag, with bets on Brazilian and Egyptian rates making money and investment in Venezuela and Puerto Rico bonds being a drag on performance. We believe significant shifts in asset prices will continue to occur as anticipations adjust to reality. Macro strategies will be able to capture and benefit from these wide market moves thanks to increasing volatility on rates and FX.


Quant strategies

Quant equity market neutral was affected by the value factor throughout the year while the momentum factor performed quite well. A rise in volatility should be beneficial for the strategy in terms of opportunities. Long-term trend-following – driven especially by equity and currency markets in general, and more specifically the technology sector and Hang Seng market, along with a positive performance on the FX market – remains the best strategy.

 

Fixed Income Arbitrage

We kept our fixed income arbitrage allocation at the same level. Despite increasing rhetoric from central banks that should ultimately lead to higher rates, volatility remained subdued. Access to balance-sheet lines in the US hadn’t been a problem in recent months as opportunities had shrunk. However, we remained confident on the strategy as Europe and Japan still offered compelling opportunities and looked forward to the December expiry. YTD, all the managers in that space delivered strong risk-adjusted return while positively exposed to volatility.


Emerging markets

Year-to-date, our EM macro managers were successful in generating returns in Asia and Latin America. There had been liquidity events in Puerto Rico and Venezuela and several situations of political instability in the Middle East. However, these crises have remained contained locally. Emerging markets still offer plenty of investment opportunities across asset classes (currency, interest-rate curve, single-name equity and debt).

 

Risk arbitrage – Event-driven

2018 started with great expectations of this strategy if Donald Trump kept his many promises: more industry deregulation, less government interference with corporate America’s ambitions, possibility of repatriating cash overseas at a friendly rate that could be deployed, among other things, in acquisitions. Even Europe, which tends to be more conservative, was emitting signals of an increasing appetite for cross-country consolidation to create European champions or to benefit from good opportunities, following strong currency depreciations. Fast-forwarding to the end of 2017, things did not play out as expected. The political noise from Washington brought many uncertainties, which led corporates to stay on the sidelines awaiting further clarification. We remain convinced that there are many opportunities to take advantage of in 2018. The new US tax regime is now a reality, traditional business models are pushing for further consolidation to be able to face tech giants, the new Franco-German entente seems ready to push ahead with the creation of stronger companies and, finally, China remains eager to snap up good businesses abroad to assert their status as an economic powerhouse. We remain mindful of the risks linked to the net long bias of event managers. Even though there is increased optimism, there is still a lot of uncertainty surrounding the details.


Distressed

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. Spreads are very tight and offer a negative risk asymmetry. Nonetheless, there have been some cracks in the painting, where the market or banks have punished severely highly levered companies that did not deliver on their promises or seemed too stretched to be viable. 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. Traditional brick-and-mortar retailers are being seriously affected by technology innovations and offer plenty of dislocations within the sector.


Long short credit & High yield

The quest for yield and the zero-to-negative rate environment are still strongly supportive of the asset class but volatility could spike if rapid changes in monetary policy surprise the market.