Politics and central bank policy took centre stage through the second quarter in the lead up, and in reaction, to the 23 June Brexit referendum, according to GAM portfolio manager Anthony Lawler (pictured).
“Across asset classes, market pricing and correlations became increasingly influenced by Brexit opinion polls. Expectation around the Brexit vote became a litmus test on emerging populism in developed market electorates,” says Lawler. “Uncertainty on the outcome of the vote, combined with an unexpectedly weak May payroll, pushed back market expectations of Fed rate hikes and lowered the expectations on terminal rates. Uncertainty and rising populism are not ingredients that help global growth.”
Bonds rallied further given these concerns, with the Barclays US Aggregate Bond index up 1.8 per cent for June and up 2.2 per cent for the quarter.
Risk asset prices were whipsawed through the quarter and with greatest amplitude in June.
The MSCI World lost 1.1 per cent for June (USD) but was down nearly 7.5 per cent intra-month from peak to trough, although it ended the second quarter up 1.2 per cent. Currencies and commodities experienced similarly high levels of volatility.
Against this backdrop dominated by political and policy risk, hedge funds managed in aggregate to produce positive performance for the month and the quarter. The HFRX Global Hedge Fund index was up 0.2 per cent for June and up 1.1 per cent for the second quarter.
Lawler says: “Hedge funds held up well in June largely because the binary nature of the Brexit vote drove most managers to reduce risk exposure ahead of 23 June. As a result, the shock of the leave campaign victory did not cause huge losses for traders initially, and most portfolios benefited from the rebound into month-end.”
Event driven managers were up in June, completing a solid quarter.
“The strategy was the best quarterly performer among the four main hedge fund approaches, even though event driven managers operated with below-average risk levels,” says Lawler. “Despite the strong volume of corporate announcements and catalysts, most event traders were defensively positioned based on macro concerns and the overhang of an uptrend in redemption requests beginning late last year. Event driven traders continue to see opportunities given the high level of corporate events as well as a growing opportunity in stressed and distressed positions, including commodity-related investments that did well in the quarter.”
The HFRX Event-Driven index was up 1.4 per cent for June.
Macro strategies were mixed with systematic traders outperforming their discretionary peers in June, says Lawler. “Systematic trend strategies were a notable outperformer in June, reversing losses earlier in the quarter, as traders were well positioned to take advantage of the risk-off sentiment leading into and out of the Brexit vote. Trend strategies were generally long fixed income in the US, UK and Europe. In addition, longs in precious metals and certain soft commodities benefited. Discretionary macro traders had low levels of risk exposure, with most traders choosing to sit out the Brexit event risk. June saw generally flat performance as popular positioning in currencies, such as long the US dollar versus commodity and emerging market currencies, was a losing trade, while beneficial positions were long Japanese yen, short the British pound and some long exposure to emerging markets that performed well.”
The HFRX Macro/CTA index was up 1.0 per cent for June.
Equity hedge funds had a more difficult time in June given their aggregate long net exposure. They were whipsawed by the violent market moves and were down for the month and the quarter.
Lawler says: “Equity market moves were increasingly frantic into the end of the quarter as correlations rose with the perceived potential for a vote in favour of Brexit. The vast majority of managers were surprised by the outcome of the vote, but performance was only moderately negative as the traders were positioned cautiously given the binary event. Following the Brexit vote, there appears to have been no notable aggressive buying, selling or sector rotation. This lack of rotation, even after such dramatic relative moves such as the financials sell-off, suggests that equity hedge funds remain cautious and are not chasing financials or other apparent new deep value trades.”
The HFRX Equity Hedge index was down 1.5 per cent for June.
Lawler concludes that GAM sees continuing opportunities for hedge fund strategies but notes that political and policy risk will remain elevated.
“The Brexit result creates new opportunities as well as ongoing risks, as investors see the ripple effects and then the actual steps taken over the coming quarters and years,” he says. “We view this as an opportunity for global macro traders in currencies, rates and trades related to diverging regional growth rates. This ripple effect can also define an opportune time for systematic strategies, as moves can go beyond what discretionary traders expect. We remain cautious on event driven exposure while standing ready to pick entry points generally and in credit specifically.”
