The market continued to push strongly ahead in December. Bears are yet to find this market’s kryptonite for them to beat a retreat. Despite the noise around the US election, and worries generated by the increasing number of COVID-19 infections and the spread of the new virus variants, investors continued to adopt a glass half-full perspective, focusing on positive news, i.e. further stimulus announcements in Japan and the US; Poland and Hungary removing their veto to the European stimulus plan; and, finally, the EU and the UK signing a deal.
Equity markets had a strong month. Small-Mid-capitalisation indices outperformed Large caps, printing high single-digit returns. Emerging Markets benefited from a positive sentiment and a weak dollar to outperform Developed Markets. At sector level, cyclicals – supported by the prospect of an economic recovery – outperformed defensives.
Corporate bond spreads continue to narrow. At the end of December 2020, credit spreads were at the same level as at the start of the year. Almost all commodities increased significantly in value during the month, Nat Gas and Cocoa being the only contracts to decrease (by low double-digits).
The HFRX Global Hedge Fund EUR returned +2.27% over the month.
Long Short Equity
It was a very strong month across the board for long-short equity funds. Since the market bottoms in March 2020, it has been a difficult environment for shorting stocks due to the strong equity performance. Nonetheless, 2020 ends up as one of the strongest years, in terms of alpha generation, for the strategy. Performance attribution was driven mainly by long investments and spreads on digital economy versus old economy, stay-at-home thematics versus businesses affected by social distancing, and renewables / green mobility versus the traditional carbon-intense industries. Fundamental stock-pickers have maintained a high average gross and net exposure. We are not yet seeing strong rotations from hedge funds into value / cyclical investments. In terms of absolute performance, US and Asia managers outperformed European funds. However, the latter have printed better returns relative to the indices. Long-short equity as a strategy, and very rich and diverse in terms of thematics and styles, possesses several tools to face different market environments.
Global Macro
Both systematic and discretionary global macro managers ended the year strongly. For December, global macro indices returned mid-single-digit returns. The month’s biggest P&L drivers were our long positions in Emerging Market rates, equities and commodities, and our short in US Dollar currency positions. Over the year, global macro was among the strategies presenting the highest level of dispersion, particularly across discretionary managers. The high level of market volatility was a moment of truth for many managers, challenged not only with proving the robustness and resilience of their investment process and risk management, but also about their ability to deploy capital. 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
2020 was an annus horribilis of sorts for quantitative strategies, which, on average, were among those printing the poorest returns across the entire spectrum. Considering quantitative funds draw their edge from analysing huge volumes of past data points to define the strategy’s current positioning, they are understandably having difficulties dealing with a totally unchartered economic environment. Short-term trend followers were a small subset of funds which managed to benefit from the different market phases, making money on the strong up-and-down market moves. Sophisticated multi-strategy quantitative funds also managed to benefit from increased market volatility levels to generate interesting returns. Nonetheless, investors were, overall, disappointed with quantitative fund performances throughout the year as most algorithms had difficulties dealing with the violent and rapid increase in market volatility and asset correlations.
Fixed Income Arbitrage
Since March 2020 and its historical level of dislocation, volatility across G3 interest rates has collapsed on the back of the clear central bank rhetoric encouraging stability to fight the pandemic- triggered economic slowdown. There have hence been fewer opportunities in that field for the last three months. However, the “low-rate environment” offers a very compelling opportunity, if US growth accelerates and – with the help of the vaccine – the situation normalizes. As we write, the financial stimulus package voted by the new administration should push the level of US govies issuance by $1.8 trillion in 2021, triggering a +10bp hike of the 7-year government bond and, further out of the curve, a steepening of the yield curve, i.e., even more negative swap spreads on the longest maturities.
Emerging markets
With 25% of the global bond market in negative yield territory as at the beginning of 2020, Emerging Markets are an appealing investing ground for investors seeking decent fixed income-yielding assets. December was a continuation of November, with managers driving strong returns from exposures to Korea, Taiwan, India, Brazil and Mexico. Prospects of a continuing economic recovery and a weak dollar are strong supportive factors of Emerging Market asset valuations. Emerging Market debt denominated in dollars or in local currencies has recovered this year’s losses and, in the case of dollar-denominated issues, are at all-time highs. Local currency-denominated Emerging Market debt has posted strong returns since the end of September 2020, most of the return coming from the appreciation of currencies said to be oversold, like the Mexican peso, the South African rand or the Russian rouble. Some analysts believe that low Treasury rates and more political stability in the US will continue to push investors to seek higher yields in Emerging Markets. The macro outlook remains extremely foggy for Emerging Markets, however, Fundamental managers consider it an interesting option in a zero-rate world; considering the fragility of fundamentals, they usually adopt a very selective approach. Caution is required, due to the higher sensitivity of the asset class to investor flows and liquidity.
Risk arbitrage – Event-driven
December was another strong month for Event-driven strategies, with positive contributions from merger arbitrage and equity special situations. Merger activity had a very strong second half-year totalling global deals valued at $2.3 trillion. This represents a 90% increase versus the first part of the year and, despite the stalemate induced by the COVID-19 pandemic during the 2nd quarter, only a 5% decline on 2019 levels. The Altice Management-led buyout was one of the month’s biggest performance contributors after the minority shareholders received a 30% increased offer for their shares. AstraZeneca’s offer for Alexion ($39 billion) and Salesforce’s offer for Slack ($28 billion) were among the biggest new deals of the month. Merger deal activity is expected to continue in the near future. Interest rates are low and corporations have cut costs and issued debt and equity not only to face the crisis, but also to be ready to snap strategic assets. The activity is driven by the necessity to restructure in stressed sectors like energy or travel, the willingness for consolidation in healthcare, financials and telecom or the need to adapt to today’s new reality by externally acquiring technologies that would take too much time or money to develop such as in the semiconductor space. As we progress towards a healthcare solution to this crisis, Event-driven will have many opportunities to deploy capital as corporations adapt and restructure to the new reality.
Distressed
Stressed and distressed strategies, benefiting from the risk-on environment, performed well during the month. Riskier issues and assets from businesses more exposed to social distancing measures, which continued to recover faster, outperformed performing credit securities. The market seems to have priced in a “sanitary-crisis-over” moment. However, in 2020, the opportunity set in distressed had to deal more with distressed sellers than distressed assets. Effective defaults will probably be below the default expectations estimated during the 2nd quarter of the year due to companies’ ability to issue equity and debt to strengthen their balance sheets. However, we are still far from a return to normality. We favour experienced and diversified strategies to avoid having to face extreme volatility swings. It is not going to be easy but this is the environment and opportunity set these managers have been waiting for over the last decade.
Long short credit & High yield
Credit spreads for Investment-Grade and High-Yield markets reached levels unseen since the crisis of 2008. The market was also highly affected by the lack of liquidity, prompting the ECB and the Fed to step up their IG debt-purchasing programmes. The Fed also decided to include high yield in its buying programmes to smooth the high amount of investment-grade fallen angels downgraded to high yield. Investment-grade and quality high-yield spreads in the US and Europe are now close to pre-COVID levels. News relating to the high level of efficacy of the Pfizer/BioNTech and Moderna vaccines pushed credit spreads even lower, leading to an outperformance of riskier issues. Although the beta trade is behind us, we think that long-short credit offers interesting opportunities, on both long and short, to capture fundamental inconsistencies triggered by this year’s strong dislocations.