October has provided an intriguing insight into the differing fortunes of equity long/short hedge funds for the year as a whole.
Some value-orientated fund managers – many of which are US-based where they remain short momentum and long value names – enjoyed a rebound in performance earlier this month, yet remain in negative territory for the year (-12 per cent). Conversely, managers running strategies related to growth and quality of earnings have been buffeted by the markets in October and have not benefited from the rebound, yet remain in positive territory for the year (6 to 8 per cent).
According to Lyxor Asset Management, long-bias strategies have gained +3.7 per cent MTD, and are up +5 per cent YTD whilst variable bias strategies are down -0.5 per cent for the month, and up +4 per cent YTD. Taken as a whole, Lyxor’s L/S Equity Broad Index is up +2.1 per cent YTD.
This may not get the pulse racing, but 2015 has been another challenging year for global markets. One only has to look at the S&P 500 Index, down -1.2 per cent and on track to deliver its worst annual performance since 2008, to appreciate that actually, a +2 per cent gain isn’t too bad on a relative basis.
US equity long/short managers have been mindful to avoid significant drawdowns this year by steadily reducing their leverage, as witnessed by the amount of net exposure (or directionality) to the markets they hold. Back in February, this number stood at approximately 80 per cent. A clear sign that US managers were feeling bullish on the economy. But since then that degree of conviction has turned more cautious. Today, the average net exposure of US managers is close to 40 per cent.
A similar trend has played out among Asian equity long/short managers, where net exposure has been reduced from north of 50 per cent to 20 per cent in September; in recent weeks, they have started to increase their leverage slightly, such that net exposure is now closer to 30 per cent.
“US managers remain cautious compared to European and Asian managers. This reflects the uncertainties in the US economy during the earnings season. Earnings released so far by US companies suggest a 6.4 per cent fall compared with Q3 2014. In October, value-orientated managers benefited from the market rebound but this was short-lived and it remains a challenging environment. The market is waiting for the Federal Reserve’s next meeting later this month, which is expected to provide some clarity on the path of future rate hikes,” comments Philippe Ferreira, Senior Cross Asset Strategist, Lyxor Asset Management.
Indeed, value managers suffered during the summer. And despite the brief recovery in performance in October, those who look for the most discounted stocks to drive returns have been left frustrated this year. Generally, value stocks are discounted for good reason; maybe companies are cutting dividends, they have uncertain growth projections.
“This investment style has continued to face headwinds due largely to the fact that global economic growth prospects remain underwhelming,” says Ferreira, who adds:
“In October, due to the rebound in risk assets that took place over the first two weeks, long bias managers have enjoyed the tailwind and have rebounded in terms of performance. Value managers have benefited from the rebound in the most discounted sectors of the market.”
One doesn’t normally associate US hedge fund managers with pragmatic conservatism. It could be argued that adding a bit of extra juice (leverage) could have resulted in bigger overall gains YTD for long-biased strategies (including value-orientated strategies). That US equity long/short managers are staying cautious shows just how critical market timing is; in other words, they are doing exactly what a hedge fund should do: limit the downside, and deliver performance (even if it is only 2.1 per cent) relative to the broader markets. The minute they see a glimpse of stronger US economic recovery, net exposure levels will tick up.
One strategy that has really suffered this year is equity market neutral; down 2-4 per cent MTD and -3.6 per cent YTD according to Lyxor’s figures.
Ferreira says that some managers have suffered from sector and style rotation in October.
“Market neutral strategies do not have market directionality but they have some implied biases based on their investment style. They can be long stocks that have outperformed recently such as growth and income stocks, and short value stocks, all the time remaining market neutral. That was the case in October, when the market experienced a sharp reversal; value stocks suddenly recovered for a short time and that impacted the overall performance of market neutral funds.
“European market neutral managers are up almost 5 per cent, but Asian managers are down -8 per cent; it’s really Asian market neutral managers that have dragged down the market neutral sub-index in October,” observes Ferreira.
This partly explains why Lyxor has seen wide dispersion in one of its Pan-Asian funds, with performances ranging from -2 per cent to +6 per cent.
Ferreira says that he expects US managers to decrease their net exposure over the next couple of months, whilst the earnings season continues to prove challenging. Net exposure will likely reach 30 per cent, converging with European and Asian managers. This would be a clear demonstration that global equity long/short managers have concerns over the sustainability of global economic growth; could there be storm clouds looming on the horizon for 2016?
Only time will tell.
What is clear is that 2015 has been a highly volatile year.
Emerging Markets have been very volatile – especially EM currencies – and commodities have also been very volatile. Bond yields rose in Europe during April and May, especially for German Bunds; the total return of the Bund was down 8 per cent in six weeks, which is quite significant (as Bund yields climbed from 0.08 per cent to 0.98 per cent through 10th June). The S&P was down 10 per cent in the third week of August. The Brent oil price fell 25 per cent in Q3. And on 27th July 2015, the Shanghai stock composite index fell 8.5 per cent, the single biggest daily loss since 2007
“These are all big numbers, making for a very challenging environment. But in relative terms, hedge funds have held up. We still see significant inflows into hedge funds this year as investors look for diversification benefits. Alternative UCITS have collected EUR50billion alone this year, which is unprecedented,” concludes Ferreira