Equity-focused hedge fund strategies are making good gains in 2015 and despite momentum slowing down in April and May, should be well placed to generate further alpha in the second half of the year.
There are three trends to pick up on:
- Strong performance among Asia Pacific managers
- European market neutral strategies improving
- Event-driven is set for a strong second half of the year
The recent rally in Asian markets has led to Asian long/short equity funds outperforming the overall Long/Short Equity Broad Index run by Lyxor Asset Management. Indeed, the index, which is up 5.1 per cent YTD, is the best performing strategy with 50 per cent of funds above 4 per cent and several posting double-digit returns.
With respect to Asian long/short equity strategies, there have been some standout performances among fund managers on the back of the rally in China and good momentum in Japan and Korea. The Shanghai Stock Exchange Composite Index is up an impressive 49 per cent YTD and has more than doubled in the last 12 months, gaining 144 per cent.
“Some Asia Pacific long/short equity managers are up 30, 40 per cent, in particular those with a long bias. For example, APS Asset Management’s APS Asia Pacific Hedge Fund is up 45 per cent this year. We also see some funds that are focusing on China that are up 25 per cent,” confirms Philippe Ferreira (pictured), Head of Research, Managed Account Platform, Lyxor Asset Management.
Recently, European market neutral managers have done well, particularly in May when they gained 1.2 per cent – putting them up 2.5 per cent YTD.
This is due to the fact that the rally in European equities has picked up the last couple of months.
“Some of the market neutral players who didn’t capture the Q1 rally in particular, which was more of a beta-driven bull market rally, are doing better now because they are generating alpha on the basis of their stock selection. These managers tend to do better and are able to generate alpha when market conditions become a bit more adverse,” says Ferreira.
More broadly, European long/short equity managers are profiting on the long side by building exposure to consumer discretionary and financial stocks and shorting energy stocks.
In the US, long/short equity managers have been in a good position this year to generate alpha. According to Ferreira, there has recently been a rotation in investment style: in April and May, value style managers started outperforming growth style managers.
“This is a repeat of what we saw the same time last year in March and April,” observes Ferreira. “Value strategies are doing better than growth strategies in the US equity long/short space although the rotation into these strategies is not as pronounced as last year; that was a very strong movement last year.
“One area of the market where these managers are investing in is the consolidation of the US pharmaceutical industry. This is an area of the market that is typically played by event-driven managers but some equity long/short stock pickers are looking with interest at the consolidation taking place to build positions.
Buyout prices relative to earnings before interest, taxes, depreciation and amortization (EBITDA) and sales for pharmaceutical and biotech companies are the highest in 20 years according to Bloomberg, reported bidnesstc.com. One example of M&A activity has been the recent USD8.05 billion purchase of Par Pharmaceutical Holdings Inc. by Endo International Plc; a deal in which Par was valued at 66 times EBITDA for 2014 and 7.5 times sales.
Signs look promising for Event-Driven
This is obviously benefiting event-driven managers as well. Overall, the strategy has done well this year, only just behind equity long/short with gains of 4.2 per cent YTD.
“These managers have delivered good performance with low volatility and this is in line with our expectations. In September and October last year we saw strong drawdowns in event-driven as a result of some deal breaks. At that point we had a view that the event-driven space would recover and now event-driven managers are just behind the equity long/short managers in performance,” comments Ferreira.
This is based on the consolidation of two main sectors: first the healthcare industry, with many new deals being announced every week, and second, the telecommunication industry.
Take for example, the Charter Communications, Time Warner Cable story. Time Warner was previously a Comcast target acquisition but the regulator signalled that it would not be in favour of such a deal. The deal collapsed but with no negative consequences as straight afterwards, Charter announced its interest and the deal went through. Indeed, Charter has now completed a pair of deals, having also acquired Bright House Networks. Both deals have seen Charter outlay a total of USD67.1 billion.
“Unless we are exposed to some big deal breaks, we should see event-driven managers do well. We are confident that this strategy is on track to having a very good year,” confirms Ferreira.
Long-term CTAs have cut their net long exposure to European rates by almost 50 per cent since May 2014 from 120 per cent to around 70 per cent. More recently, in May, short-term CTAs cut their net long position on rates from 40 per cent to near zero per cent.
Both instances show that CTAs are positioning themselves for stronger European economic growth and raising bond yields.
Ferreira is quick to point out that some media stories have been quick to point the finger of blame at CTAs for their role in the bond market sell-off.
“Some broker reports have said that CTAs have been the main perpetrators of the sell-off but we have a comprehensive view of CTA activity at Lyxor and this is just not what we are seeing. CTAs were merely following the market trend, as you would expect, in European bonds.
“Although their net long position in European rates has reduced in recent months, long-term CTAs are still net long and as such are the victims of the sell-off rather than the ones responsible.”
CTAs experienced a drawdown in May, which was the result of several factors, one of which being the sell-off in European rates. Another cause for the drawdown was a trend reversal in commodity prices as they recovered in May, even though CTAs were still short. Although as Ferreira points out, in the last couple of weeks CTAs have started to recover as commodity markets have normalised.
The net result was that the CTA Broad Index incurred losses of -5.7 per cent in May, leaving the strategy at 1.4 per cent YTD.
“CTAs have cut their long USD and short energy positions in both these areas for the time being but expectations are that we will see an improving situation in the US economy in the next couple of quarters. Hence, CTAs should benefit from an upward trend in the USD. We therefore believe that CTAs will have a stronger second half of the year, much like event-driven,” says Ferreira.
Moving forward, if the trend of a stronger USD resumes this will weaken commodities and should support a stronger downward trend; that’s all that matters for CTAs. It doesn’t matter what way the trends are going.
“The downward pressure on commodities should resume although we may not see the extent of the drawdown as witnessed last summer. It will likely be less pronounced and as a result the overall contribution of commodities to CTA returns will probably be less prominent.
“In Europe, the ECB is committed to pursuing its QE programme and this should also support further downward momentum in European rates. So there are several trends that we think will continue to emerge in the coming months, which CTAs should be able to benefit from,” adds Ferreira.
Macro managers, overall, are up 4.5 per cent YTD. From a performance perspective they are probably the most heterogeneous set of managers to analyse.
“You have pure commodity players, highly diversified managers, so the aggregate view tends to be a bit misleading given the wide mix of managers. The performance is slightly up YTD but there is quite a strong level of divergence; some of the largest macro managers this year have been delivering double-digit returns and part of this can be explained by their taking a negative stance on European interest rates. They have been shorting rates in anticipation of higher yields, in Germany in particular,” says Ferreira.
In April, the timing was appropriate as German 10-year Bunds were trading below 10 basis points. Then, between 17th April and 13th May, yields climbed from a record-low 0.049 per cent to 0.72 percent. They’ve since dropped back to 0.49 per cent.
In addition, Germany’s 30-year Bund yield has surged from a record-low 0.435 percent on 17th April to 1.38 per cent.
This has bolstered the performance of some global macro managers who were able to generate 5 to 7 per cent in the first couple of weeks of May.
“It has been the main story for macro players – the fact that they’ve been shorting European bonds and expecting bond yields to climb on the back of expected economic growth in the region. The threat of a ‘Grexit’ has not been a factor in managers taking this short position on European rates. Will Greece exiting the euro lead to lower or higher European bond yields? It’s a tricky question. It should probably benefit German Bund prices and drive yields lower.
“With respect to currencies, global macro managers have taken a similar stance to CTAs, going net long USD and short the euro; that’s been the most actively traded currency pair. Conversely, whilst CTAs are still short commodities, global macro managers have been taking a net long position with limited conviction,” confirms Ferreira.
Credit and Fixed Income
Fixed income managers have played their role as a hedge during the market turmoil at the beginning of May. Fixed income arbitrageurs, in particular, took advantage of higher volatility in Europe, which presented arbitrage opportunities across the curve; something that Ferreira and his team expected to see: “Fixed income and credit managers should do better in higher volatility environments, and they did.”
Convertible bond arbitrage strategies gained 1.5 per cent in May although they are still down -1.1 per cent for the year.
Credit long/short managers who have focused on Europe this year have done well as a result of continued spread compression in European high yield corporate bonds.
In the US, managers have been rather negatively impacted by developments in the oil and gas sector; companies have posted weaker earnings on the back of falling prices and this obviously impacted bond prices.
“Some managers with exposure to these companies suffered losses in Q1 but more recently, since commodity prices have rebounded and there’s been higher interest rate volatility this has proved to be a positive development in May – the L/S Credit Arbitrage Index gained 0.6 per cent in May and is now up 1.0 per cent YTD,” states Ferreira.
In Europe, credit long/short managers have been positioning themselves against improving economic conditions in the region and have been looking at cyclical sectors such as industrials and technology; the theme is one of buying in to the European recovery story. This is similar to global macro managers who are taking a short European rates stance.
“Basically the start to the year has been quite strong. We saw some lower momentum in April and May when the S&P 500 Index experienced a degree of trend reversal, which impacted CTAs. However, we expect the positive momentum in Q1 to kick on in the second half of 2015 on the back of higher volatility in rates and renewed trends in markets such as commodities, which will benefit certain strategies,” concludes Ferreira.