There are currently so many headwinds to the economy that it is difficult to isolate THE driver that is having the biggest impact on deteriorating economic fundamentals in only a small paragraph. That said, the fear of a hard landing for the major economies, and more specifically the United States, has become material, and reflects all the economic woes we are now facing.
The greater probability of a recession has pulled equity markets to the ground. The vast majority of equity indices ended the month in the red, adding to an already poor first quarter in terms of performance. Technology and small cap indices suffered the most, declining by high single-digit to low double-digit returns. At sector level, cyclicals, pricey tech and consumer discretionary stocks underperformed energy and defensive sectors like consumer staples and utilities.
Sovereign yields continued to move up. US Treasury yields shifted up across the curve, which however remains almost completely flat. Credit spreads continue to widen slightly, but remain close to 2020 tights.
Natural gas, coal, oil and soft commodity futures continue to rise, while industrial metals declined by low to mid-single-digit returns.
The HFRX Global Hedge Fund EUR returned -1.05% during the month.
Long-Short Equity
Long-Short Equity indices were negative for the month. Growth bias strategies have been the shining stars of the last ten years, but negative performance contributions from growth managers in technology and consumer discretionary sectors pulled down average performances. However, performances for Long-Short funds were relatively dispersed across the spectrum. Market Neutral Long-Short Equity funds and Value bias stock pickers put in decent performances. On average, Long-Short Equity Funds started the month low on risk after continuously lowering their gross and net exposures since the start of the year. During April, their relative performance was positive, with low downside capture ratios. As mentioned previously, we do not expect funds to add significant levels of risk for the moment, but rather invest selectively in longs, and refresh and reinforce their short books. Over the short term, we expect good Long-Short Equity strategies to protect capital for their investors by maintaining gross and net exposures close to their lower ranges. The war is exacerbating some of the challenges companies around the world are facing. Picking the right stocks will be important, but being able to do so from a long-short perspective can bring a solid edge to long-only equity solutions.
Global Macro
On average, Global Macro managers performed well over the month, as they have been among the biggest beneficiaries of rising volatility levels, confirming the saying that every story can be seen from different perspectives. Savvy discretionary and systematic strategies have leveraged a higher volatility regime and asset risk premium repricing in equities, rates, currencies and commodities to deploy capital in successful investments. Long positions in commodities and shorts in equities generated the best performances, but macro managers specialising in rates have been able to print decent returns. We have said in previous articles that Global Macro would have a better environment to deploy capital, as central banks were starting to reduce liquidity injections and plan for rate hikes. This infamous war has just jump-started some of the market volatility that we were anticipating due to less fiscal and monetary support. Asset risk premiums are moving across the board, and macro managers should be able to capitalise on these market moves. We continue to favour discretionary opportunistic managers who can draw on their analytical skills and experience to generate profits from selective opportunities worldwide.
Quant Strategies
It is still hammer time for quants. April was another strong month for quantitative strategies, which continue to reap the benefits of a higher volatility regime. Trends in rates, currencies and equities remain strong positive performance drivers. Blue chip Multi-Model Quant strategies are also doing very well, generating high double-digit returns since the start of the year. For the last three years, these strategies have been great diversifiers from traditional assets, which are generating some of the worst year-to-date returns of the last 20 years.
Fixed Income Arbitrage
Inflation forces took the lead and pushed yields higher, on the back of the Fed’s hawkish rhetoric and pervasive inflation. However, the implementation of higher interest rates will be gradual, and the Fed will stay far beyond the curve if inflation stays at its current levels. The impact on the yield curve was quite straightforward: the yield curve steepened and the long end crept 50 bps higher, flirting with the 3% mark. April saw the same perfect playground for fixed income managers (directional or relative value): the short part of the US yield curve underestimating both the magnitude and the pace of rate hikes, the long end of the curve moving higher, volatile swap spreads, and volatile futures basis across the yield curves. In this environment, fixed income managers took advantage of the very supportive environment to post strong returns.
Emerging Markets
Emerging Markets strategies suffered as a result of two major idiosyncratic events, a war in Eastern Europe and China’s zero-Covid policy, but also from a general risk-off sentiment. Conversely, the strength of commodity prices has provided strong support for opportunities in Latin America and other export-driven nations. Performances varied across managers, depending on their area of focus. There are few hedge funds covering emerging markets. They tend to be specialists in narrower geographical regions. This strategy offers selective investment opportunities, but we remain overall cautious for the moment, as decreasing growth expectations and rising interest rates in developed markets are warning indicators for the region.
Risk arbitrage – Event-driven
Event-driven strategies were relatively muted during April. Merger arbitrage strategies were overall flat for the month, because positive contributions from deals progressing positively were negatively offset by slightly widening spreads due to a more uncertain environment. Credit markets are still working, allowing deals to financed. Conversely, the higher volatility of stock prices and the revision of earnings guidance might prompt deals to be renegotiated. Strategies with higher exposure to Special Situations in the energy space have tended to outperform peers. For 2022, the industry does not expect a repeat of last year’s record activity in deal making, but they do expect to have plenty of deals in the pipeline to deploy capital on. Rising interest rates and equity volatility are risk factors to be taken into account more seriously going forward, but it will help maintain wider spreads and keep the strategy less crowded. With investors currently looking for diversification, merger arbitrage provides an interesting tool that is structurally short-duration, where deal spreads are positively correlated to rising interest rates.
Distressed
Credit spreads are widening slightly, but the environment is relatively calm for distressed strategies for the moment. Apart from specific cases, spreads in bonds, loans and structured products remain relatively tight. While the opportunity set remains relatively modest, current economic uncertainties can no longer be easily overlooked, as current inflation levels will limit the possibilities for central banks to again save the market. Furthermore, reference rates are still close to the bottom, as the Fed has just started raising rates, and the ECB seems to be following the same route at the beginning of summer. Volumes of issuance since 2010 have been very high, and credit access conditions have been relatively loose, so the pipeline of opportunities should be relatively full. The geopolitical and economic changes caused by the war in Ukraine will not help make it easier going forward.
Long-Short Credit & High Yield
In Europe and emerging markets, credit spreads have widened, but remain relatively close to their historical lows in the US. Investors now believe that the power of the “Fed put” will progressively start to fade away, improving the opportunity set for credit picking from a Long-Short perspective. Chinese real estate-related credit opportunities are making their way into some of the hedge funds with research capabilities in Asia. Although the Evergrande debacle is still on everyone’s mind, the possibility that the Chinese government would allow a repeat of a Lehman-type scenario is thought to be less probable, considering the importance of real estate to the Chinese economy. Emerging market credit spreads have widened considerably. This is an opportunity considered appealing by many managers, since EM central banks are considered to be ahead of the curve tightening policy, and high commodity prices will help exporting nations keep their balance sheets in check.