February was a risk-on month in markets, with investors deploying capital and equities rallying globally, while perceived safe-haven assets, such as US Treasuries, UK Gilts, German Bunds and gold sold off.
The MSCI World index was up 5.9% in February, which more than offset January’s losses. This backdrop proved positive for hedge funds with the HFRX Global Hedge Fund index up 2.0%.
February’s buoyant equity and credit markets were largely a continued reflection of the expected impact of the ECB’s January QE announcement, according to Anthony Lawler, portfolio manager at GAM.
“Following the announcement, hedge fund exposures were rewarded and new trades initiated across each of the four main strategies,” says Lawler. “In the equity hedged strategy, net and gross exposure levels are back to as high as at any point over the past 12 months as traders see dispersion in equity returns and further upside, especially in Europe and Japan. Dispersion of growth rates is helpful, and generally investors are turning more positive as evidenced by hedge fund exposures rotating out of bond-like utilities and other defensives into cyclicals and consumer discretionary ideas. Equity exposures, be it in equity hedged, event driven or tactical global macro strategies, are increasing. We view this shift as warranted as the dataset in Europe is slowly improving, earnings are being revised up and investors are taking note. Across the pond data shows US growth to be stable and corporate equity buy-back programmes continue on a large scale.”
Equity hedged and event driven were the two top-performing hedge fund strategies in February, returning 2.3% and 2.7% respectively, according to HFRX strategy index data.
Increased volatility, driven by changes in expectations of growth rates and interest rates, was generally helpful to relative value and global macro traders, according to Lawler.
“These strategies both tend to benefit when volatility increases, as was the case in February.” he says. “The US is considering reducing its monetary accommodation, while Europe, China and certain emerging markets remain in easing mode. This divergence of policy paths is helpful for relative value and global macro traders who have been trading the opportunity set via currencies, interest rates and equities.”
The HFRX Relative Value index was up 2.0%, while the HFRX Macro/CTA index gained 0.7%.
According to Lawler, valuation levels in credit are high enough to make investors cautious on expected strong long-only and yield returns from here.
“One of the on-going impacts of easy global monetary policy and QE is that investors seeking a set level of return are forced to find more risky, higher-yielding assets and move away from the perceived safety of sovereign bonds,” he says/. “This has caused investment grade and high yield credit to rally significantly. We are seeing high yield continuing to attract flows, even though total expected returns are not as high as long-term averages. Some investors are now looking for ways to diversify away from the risk of rates rising and credit spreads widening at some point. One way to do that is to shift from longs into relative value positioning in these markets, and we are seeing some of that repositioning in hedge funds that trade credit and interest rates. But all of that said, our base case remains that the world continues to be in yield-chasing mode across credit assets, albeit at a point of high valuations relative to history.“
