UCITS “makes even more sense”: Liquid alts deliver diversification amid pandemic crash, says Lyxor

Coronavirus impact

UCITS hedge funds delivered on their pledge of portfolio diversification during the coronavirus-fuelled market meltdown this year, and investors should now consider putting more of their money into the sector to seize on continued market dislocations, Lyxor Asset Management says.

A new Lyxor study led by Bernadette Busquere Arnal, European head of hedge fund research, and Nathanael Benzaken, chief client officer, forecasts further growth in alternative UCITS, after the sector outflanked broader market indices during the Covid-19 crash in March.

The commentary also suggested the pandemic is further driving sustainable investment trends among UCITS hedge funds.

While the HFRI Liquid Alternative UCITS index slipped 7.49 per cent during Q1, the MSCI World index plummeted almost three times as much, losing 20.94 per cent.

As markets were rocked by the spread of coronavirus, UCITS managers were able to stem losses through a mix of efficient short-selling, relative value trades and hedges.

“We believe allocating to liquid alternatives makes even more sense in the current context,” Benzaken said in the report.

He said the continuing fall-out from the coronavirus crisis has created major dislocations that can be monetised by hedge fund managers.

“With major indices rallying back to near pre-crisis levels, it may even be more relevant now to consider building or adding to a ‘diversification’ portfolio.”

UCITS-compliant hedge funds set strict curbs set on leverage, liquidity and position sizing, which means some strategies at the more illiquid end of the spectrum typically cannot be replicated in a UCITS structure.

Benzaken pinpointed CTAs and long-short equity funds, including market-neutral strategies, as among the fund types that fared best during March’s maelstrom, with merger arbitrage, discretionary equity, credit and relative value also performing strongly.

On the flip-side, global macro, volatility and risk premia hedge funds lagged the rest of the UCITS pack.

“You’d expect CTAs to do well in a sharp sell-off as they are supposed to cut exposure as soon as volatility spikes and asset class correlation increases,” Benzaken said of performance.

“Helpfully, some funds’ risk models also gave them advance warning of a problem: many systematic equity funds had already reduced their exposure before the crisis happened, as the rising market volatility in early to mid-February caused them to cut back on positions.”

Looking ahead, the pair pointed to rich opportunities arising for UCITS hedge fund strategies across credit, equity, currency and fixed income markets.

Alternative UCITS funds, which have traditionally been favoured by continental European institutional investors, managed EUR385 billion at the end of 2019, accounting for some 3.5 per cent of the overall UCITS market.

Benzaken said: “An increasing proportion of the world’s largest hedge funds are looking to diversify their client base away from North America into Europe, Asia and Latin America. UCITS are native to Europe but have also seen strong traction in recent years in these two other geographical regions.”

Lyxor is also planning to integrate ESG criteria in its liquid alternative UCITS products.

“It’s unquestionable that the Covid-19 crisis has accelerated the trend towards sustainable investing, and we want to play our part,” Benzaken added.