The European Central Bank’s “whatever it takes” promise has substantially reduced tail risks, according to Lyxor.
Risk premiums that have remained abnormally high since the outset of the financial crisis should diminish over time. The road to normalization will probably be long and bumpy, however.
While policy uncertainties persist in the Eurozone, they are mounting in the US which is facing the so-called “fiscal cliff”. But the aggressive monetary policies across the world mean that the trough in the economic cycle could occur earlier than we previously had in mind.
Strategically, Lyxor continues to favour US assets but has tactically raised its stance on the more volatile Eurozone equities to the same slight overweight stance. Fundamentally, austerity continues to take its toll on European growth, thus compromising fiscal targets. Within emerging markets, Lyxor believe EM equities should soon benefit from additional policy support and later from improved economic momentum.
The most striking feature of financial markets since the crisis is probably investors’ inordinate antipathy towards equity.
Current equity risk premiums are far above their long term average and, in most cases, close to the maximum reached in the last two or three decades. Lyxor believes the normalization of these risk premiums should be a powerful driver of financial asset behaviour over the medium term.
In particular, it could compensate for sluggish global growth and poor earnings prospects. The ongoing reflation / normalisation theme warrants a more constructive stance on equities. Lyxor Quant Research proprietary macro signals are also showing a modest rise in risk appetite with a slight preference for equities versus bonds.
The call is more subtle than simply “add beta”, as Lyxor recognises that hedge fund managers are benefiting from stock selection. In other words, there is a window right now for adding beta and alpha – both for managers of hedge funds and for investors in portfolios of hedge funds.
For the moment, there is a bit of visibility for investment managers. While it lasts, Lyxor suggests that stock selection is capable of adding alpha to the beta reward captured by L/S Equity managers. During the somewhat disappointing Q2 earnings season, when EPS often beat expectations but revenues often missed, managers had the raw materials required to generate returns: single stock fundamentals – not just rumours about policy - were key for stock returns.
“Hedge funds are taking advantage of this window of visibility and are putting on appropriate risk exposures in order to capitalise on the situation. We believe that select managers can trade around the markets and can extract both alpha and the reward for beta,” says Jeanne Asseraf-Bitton, head of cross-asset research at Lyxor Asset Management.