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Following 3 weeks of tactical retracement to digest the
year-end rally, multiple events in Emerging contributed to
unsettle EM and DM markets – in particular global equities,
USD-JPY, and weaker US LT yield. Weak PMI in China,
concerns about the vulnerability of its shadow banking and
instability in Turkey, Argentina and Ukraine, awoke broader
investor concerns. Concerns about a risk of contagion from EM
twin deficits countries. Concerns about the pace of global
recovery, as economic readings weaken. Doubts on central
banks’ will to do ‘whatever it takes’.
After a quiet start, the
strategies most directionally exposed to equity markets – L/S
Equity, Special situation and CTAs – have detracted
performance by month-end. In contrast, relative value
strategies have successfully weathered market instability.
L/S Equity funds entered 2014 with a reasonably
constructive outlook. They shaved off some of their exposure in
early January. Long bias funds reduced their gross exposure
by around 10%, variable bias reduced their net exposure from
45% down to 35%.
With a strong overall exposure to cyclical
sectors though, their average market beta continued to hover
around 35%. Rising equity dispersion, the start of the earnings
season, and healthier short trading conditions were favorable to
variable and market neutral bias funds.
They outperformed long
bias funds prior to the sell-off. Afterward, European funds
outperformed their US peers. Long bias funds ended January
down -1.6%, variable bias up +0.5%, and market neutral funds
were up +0.8%. Hedge fund managers haven’t meaningfully
altered either their gross or their net exposure so far, which is a
sign that they aren’t buying an EM contagion scenario for now.
Similarly Event driven funds produced positive returns
during the first part of January. Range trading equity markets
had a limited impact on deal-specific merger spreads.
Increased flows of M&A deals early this year provided a fresh
pool of opportunities for managers.
Meanwhile the main activist
positions held in portfolios continued to progress.
Unsurprisingly, rising risk aversion in the second part of January
dented into merger spreads and into the long exposure of
special situations funds.
While the environment remains
supportive for merger funds, cooling liquidity in the US and
more fairly valued companies will likely incline hedge fund
managers to be more selective.
In Japan, a capex rebound and corporate cash hoarding bode
well for M&A trends, in particular in cross borders, which have
represented the bulk of Japanese operations since 2012. The
Merger arbitrage funds ended January up +0.9%, and the
Special Situation funds down only -0.2%.
Dispersion among CTAs was striking during the month.
Long Term CTAs were down as much as -5.4% in January, in
contrast with Short Term CTAs ending up +0.4%. In the first
part of the month, long term funds generated performance on
commodity FX shorts and long USD positions.
Meanwhile,
directionless equity markets provided limited opportunities for
short term CTAs, flat over these 3 weeks. The wheel then
turned, with a dominant exposure to equity.
Long term funds
took a severe hit, on their JPY-USD cross exposure as well.
Equity losses incurred by Global macro funds during the
sell-off were offset by gains accumulated earlier in the month –
in long duration US and EU trades in particular. They ended
flat.
FX and LT rates are their largest gross exposures as we
enter February. They enjoy a growing set of opportunities from
DM’s central banks dispersion and relative value trades in EM
markets.
While net neutral on EM FX and Energy, their average
60% gross exposure on these 2 markets illustrate some of their
market themes.
Softer data in the US and a slight disappointment from the
Fed’s resolution to maintain its envisaged pace of tapering
provided a favorable backdrop for credit and fixed income
funds. CB managers and credit arbitrage funds accumulated
small gains in the early part of the month, courtesy of marginally
tightening credit spreads.
Later on, rising implied volatility
mitigated the losses incurred by CB managers on the equity
component during the sell-off; and L/S Credit funds’ cut in their
net exposure from 70% to around 40% during the 3 first weeks
of January, mitigating the impact from widening spreads across
the board.
They all ended up the month with positive returns,
up +0.5% on average.
Hedge funds have taken the lead in asset class ranking in
January, with relative value approaches offsetting losses in
more directional strategies. “Healthy market dispersion, EM and
DM macro themes, a set of micro arbitrage in corporate
operations, EPS releases, sector rotation: some of the key
ingredients for alternative investments’ outperformance”, says
Jean-Baptiste Berthon, senior cross asset strategist at Lyxor
AM.
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