March proved to be a choppy month with geopolitical risk flaring up in Ukraine and the unexpected hawkish language from the Fed causing risk markets to react before generally recovering into month-end.
Anthony Lawler, portfolio manager at GAM, notes that despite slightly negative returns for many hedge funds during March the first quarter was positive for three of the four main hedge fund strategies.
Managers continue to find opportunities created by dispersion across asset classes and markets.
"We continue to be positive on the opportunity set for hedge funds given the dispersion we are seeing within asset classes such as equities, and also the divergence in growth and monetary policy paths around the world,” says Lawler.
"Taking equities as an example, we are seeing stock and sector specific positions grow in size, and in bonds we see relative value trades such as US rates curve versus European rates curve being added. Managers are running elevated gross exposure levels which show their conviction, especially those trading event driven and equity long/short strategies."
The HFRX Global Hedge Fund index was down 0.2 per cent for March bringing the year-to-date return to 1.1 per cent in US dollar terms. The HFRX strategy level indices for event driven, equity hedge and relative value are up year-to-date 2.8 per cent, 1.2 per cent and 0.9 per cent, respectively, while the HFRX Macro/CTA index has returned -1.0 per cent for the year, all in US dollar terms.
GAM continues to see opportunities in equity-related strategies, says Lawler: "Event driven and equity long/short managers weathered the choppy markets in March. Their full gross exposure positioning demonstrates positive expectations to generate returns. Last year net exposures for these managers were higher than they are now, coinciding with our view that the potential in 2014 lies in relative value positioning, security selection and industry selection, rather than simply long broader market beta."
According to GAM demand for credit and bonds surprised many investors this quarter.
“Given the strong performance last year and tight credit spreads, investors did not expect much more upside in credit this year,” says Lawler. “In the first quarter the demand for yield was notable as investors bought volumes of credit and even sovereigns. This reach for yield is reflected in the overly permissive terms being accepted in new credit issuance. This risk was highlighted by the Fed when Yellen cited 'deteriorating underwriting standards,' cautioning against these new covenant light deals. At this point we are not bearish credit but remain cautious given the tight spreads, the often poor covenants and the potential for this market to have low liquidity in a flight to safety scenario."
Global macro managers were not rewarded for their core trades in the first quarter and, as a result, Lawler says that some managers are positioning into more relative value trades.
"More relative value trades are now being put on, partly because the directional conviction trades did not play out in the first quarter, despite a strong underlying thesis. Later this year there may be upside for some of these larger trades such as long US dollar positioning, the Japan reflation trade and the China slowdown risk. While managers wait for those types of directional trades, they are now seeing more opportunity to trade interest rate curves, volatility, and relative value trades in bonds given the differing policy paths we see globally."