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Volatility and correlation reign in August, says GAM

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August was a very volatile month for capital markets. Risk assets sold off without a corresponding offsetting rally in traditional safe-haven assets, such as sovereign bonds or the US dollar.

The MSCI World index was down 6.6 per cent while neither the Barclays US Aggregate Bond index nor the US Dollar index managed positive returns, ending the month down 0.1 per cent and 1.6 per cent, respectively. Commodities were broadly weaker aside from gold and oil, with oil moving from deeply negative mid-month to end up about 4 per cent following a 28 per cent rally in the last three trading days of August. This volatile and correlated backdrop across asset classes proved challenging for active managers and hedge funds. The HFRX Global Hedge Fund index ended August down 2.2 per cent.All returns stated in US dollar terms.
The volatile and correlated markets caused portfolio risk to be reduced in aggregate across each hedge fund strategy as investors looked to preserve capital, according to Anthony Lawler (pictured), portfolio manager at GAM. “We saw gross and net exposures reduced during the second half of August across all asset classes, which is unusual,” he says. “It is a sign that investors are choosing to step back and wait, rather than add to risk exposures during this choppiness.”
The volatility and reversals in August did not benefit any major category of investors, says Lawler: “Investors across all strategies typically own some form of risk assets as their primary strategy. This makes a very correlated sell-off in almost all asset classes challenging. For a sense of how big the shocks were in August we can look at equity volatility. The VIX equity volatility index spiked to over 50 on 24 August, having traded below 25 all year. This was the first time since 2009 that the so-called ‘fear index’ touched above 50. This extreme move in volatility was not contained to equities but spread across asset classes. This volatility was combined with unusually high cross-asset correlations, with the US dollar and even most bond markets weakening in August in addition to weakness in risk assets.”
For equity hedged traders, the fact that individual equities were highly correlated with each other meant that alpha from single-name selection was not rewarded in August, says Lawler. “When markets have a very correlated move, it is usual for equity hedged traders to at best perform in line with their net equity exposure as the market doesn’t reward single-name fundamentals. In fact for some traders, such as those in the event driven space, a sell-off which comes with an increase in volatility can cause risk reduction selling given VaR (Value at Risk) has increased. This causes well-researched names that are broadly held to sometimes trade down more than the broader market as active managers all trim their respective exposures. Months like August create opportunity in that quality ideas are overly punished and could offer good entry points, but during correlated volatility, it is difficult for managers to outperform.”
Global macro traders remain optimistic on the trading environment but they were not immune from the challenges with several conviction trades being hit in August, says Lawler. “Macro investors generally continue to believe that US dollar strength will persist and that the dispersion in global outlooks offers solid opportunities to trade. Nevertheless, that was a tough trade in August which did not reap dividends. In emerging markets, some short currency positions helped but traders suffered expecting Brazil to need to cut rates when instead the market turmoil led to Brazilian yields moving higher. In commodities, the short energy positioning was helpful until the strong reversal in the last few days of the month. In regional equities, macro traders had small long holdings, mostly in Europe and Japan, both of which were unprofitable on the month. We believe that reaction through August from macro traders has largely been to reduce risk but not to change their conviction views at this point.”

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