Philippe Ferreira

Philippe Ferreira

Director, Senior Cross-Asset Strategist

Lyxor Asset Management


Merger Arbitrage stays put in Market Reversal

12 Feb 2018

Investment Partners

 

Recent market movements took a heavy toll on equities. Solid wage numbers released recently in the U.S. exacerbated anxiety over monetary tightening and yields normalization. However, such events are not rare. The 10% fall in the S&P 500 between January 26, 2018 and February 8, 2018 is of similar amplitude than corrections in August 2015 and January 2016. If recent history is a lesson, it tells us it takes some time for investors to regain confidence. Treasury auctions will be heavily scrutinized and U.S. CPI numbers to be released this week will be key. The consensus expects core CPI edged lower in January (+0.2% month-on-month, down from 0.3% in December). Meanwhile, technical indicators point to U.S. stocks being oversold.

Where does it leave us? Risk-prone investors should consider tactically adding risk and be ready to trade unstable markets in coming weeks. Risk adverse investors should stay on the sidelines until the market switches its focus to the strength of fundamentals, be it global economic activity or earnings expectations.

On the alternative front, there is no such thing as a trend reversal to hurt CTAs. The Lyxor CTA Index underperformed last week, down -3.9%. Several managers had started to cut leverage ahead of the event and managed to limit losses. The performance of a sample, wider than the index discussed above, ranges from -2% to -15% since early February. Most funds are now in negative territory YTD. L/S Equity funds also suffered a -2.2% drawdown last week.

On a positive note, merger arbitrage fared very well and matched expectations regarding their ability to deliver returns uncorrelated with market movements. We reiterate our strong convictions on the strategy, with U.S. deal spreads above 7% early February and strong global M&A activity so far in 2018, especially in the U.S. Finally, low beta L/S Credit funds also fared well though it is worth noting that the selloff has largely spared the credit market globally. We also maintain an overweight stance on low beta L/S Credit while holding to our neutral stance on CTAs.


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