Philippe Ferreira

Philippe Ferreira

Director, Senior Cross-Asset Strategist

Lyxor Asset Management


Market Tailspin Drags Hedge Funds Lower

15 Oct 2018

Investment Partners

Higher bond yields and political uncertainty took a toll on risk assets last week. In the U.S., business surveys at record highs and the unemployment rate at multi decade low raised fears of overheating. Treasury yields were on the rise since late August and the yield curve steepened. This selloff thus shares similarities with the February selloff and is not related with recession fears, on the contrary. Concurrently, the standoff between Italy and the EU on fiscal expansion and the rocky trade negotiations between the U.S. and China have amplified market concerns.

Hedge funds were not immune from market developments. They were down almost 2% last week (from Oct. 3 to 10), due to the underperformance of L/S Equity, Special Situations and CTA strategies. Merger Arbitrage strategies were slightly impacted by the widening of deal spreads but managed to outperform overall. Fixed Income Arbitrage, L/S Credit and Global Macro strategies were resilient thanks to their cautious positioning. L/S Equity Market Neutral strategies were slightly down. Overall, it is important to note that dispersion between fund returns was elevated, especially for L/S Equity (including Market Neutral) and Global Macro where several strategies managed to deliver positive returns based on their defensive positioning.

In our view, worries about overheating are overdone. The U.S. economy is set to decelerate as the fiscal boost will soon fade (see Fed estimates). We don’t think the Fed will accelerate tightening as inflation is converging to the 2% target. Yet, we expect markets to remain volatile. Risk appetite tends to recede gradually after episodes of stress. In the midterm, we expect the volatility regime to stay high compared to recent years. Next year, overheating concerns might give way to recession fears as growth decelerates. Finally, our views on alternative strategies were comforted in Merger Arbitrage and Relative Value Arbitrage (Overweight) but challenged on CTAs. Trend followers took a hit last week due to long equity positioning as well as fixed income and commodity allocations (long oil, short precious metals). The drawdown was however milder compared to earlier trend reversal episodes this year. The selloff led to portfolio deleveraging, suggesting the strategy might not benefit from a market rebound if it takes place. However, if markets remain volatile for some weeks, as we expect, the strategy should be resilient. We stay constructive going forward.


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