Philippe Ferreira

Philippe Ferreira

Director, Senior Cross-Asset Strategist

Lyxor Asset Management


Momentum Reversal Hurts L/S Equity

02 Jul 2018

Investment Partners

Risk assets were under pressure during the second half of June as trade war concerns escalated. On June 14th, the medias reported that President Trump approved tariffs on Chinese goods worth about $50 bn. A few days later, the U.S. President threatened to place further tariffs on Chinese goods, up to a total of $450bn of imports. Since mid-June, the MSCI World was down almost 3% on fears of trade retaliation and escalation.

The equity market selloff has been accompanied by a sector rotation which has gone somewhat unnoticed. Cyclical sectors which outperformed since the beginning of the year (IT, Consumer Discretionary and Materials) corrected sharply since mid-June in the U.S., the EMU and to some extent in China. Meanwhile, defensive sectors that underperformed earlier (Utilities, Consumer Staples and Telecommunications) outperformed since then. Translated into the world of equity risk factors, this movement is a beautiful (and painful) momentum reversal in favor of low beta stocks. Momentum is the strategy of buying stocks that have gone up during a specific period of time and shorting stocks with the lowest returns over the same period. This risk factor was popularized in the academic literature by Jegadeesh and Titman in the early 90s.

In the hedge fund space, L/S Equity tends to suffer the most from momentum reversals in equities. The strategy underperformed in June because it was on the wrong side of both trades; i.e. long momentum and short low-beta stocks (see second chart). L/S Equity market neutral funds were also down, but less than traditional L/S funds because the later has a structural market beta of about 30%. Special Situation funds also got hammered due to their elevated market beta. On a positive note, both L/S Equity and Special Situation funds did better than the overall equity market. Moreover, Merger Arb. and Relative Value Arb. were left largely unscathed by the market turmoil and delivered returns in positive territory for the full month.

Our investment views were not impacted by recent market developments. We maintain an overweight stance on Merger Arb., Fixed Income Arb. and L/S Equity Variable Bias. Our stance on L/S Equity and Special Situations stays at neutral while we are also defensive on CTAs and Global Macro.


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