Philippe Ferreira

Philippe Ferreira

Director, Senior Cross-Asset Strategist

Lyxor Asset Management

L/S Credit Rally as Draghi Goes the Extra Mile

12 May 2016

Investment Partners

In April, dovish central banks and better than expected Chinese data contributed to stabilize markets after the March rally. The credit space was supported on both sides of the Atlantic: in Europe by the ECB announcing its corporate bond purchase program, in the US by the oil rally. As a result, credit spreads tightened in both the high yield and investment grade segments. Meanwhile, US and European sovereign bond yields, which stand at historical low levels, widened when risk-on sentiment rekindled. Equity markets progressed mildly in the US, Europe and EM, while Japanese equities lost some ground. The US dollar continued to weaken in particular against the JPY and EM currencies.

In that environment, the Lyxor Hedge Fund Index was down 1.3% through the month, with CTA and Macro managers underperforming. While CTAs suffered from the rise in bond yields, Macro managers were hurt by their FX and equity portfolios. L/S equity funds’ returns disappointed on the back of their cautious stance. The bright spot was the Fixed Income and Credit Arbitrage strategy that was up 1.7%.

Fixed income and Credit arbitrage outperformed, fuelled by commodity and dovish ECB tailwinds. All Lyxor L/S credit managers ended the month in positive territory, with Asian credit managers outperforming. Their holdings in the energy, basic materials and consumer cyclical sectors were particularly rewarding in April.

Event Driven managers limited losses (-1.2%) despite the Pfizer/Allergan deal break. The merger was canceled amidst increased US regulatory pressures aiming at discouraging tax inversion operations. While a number of Event Driven managers were positioned on this transaction, the average loss on portfolios was moderate. The managers’ overall limited exposition to inversion deals kept contagion impacts under control. Merger arbitrage ended the month down 2% although losses were partially offset by the spread tightening on numerous deals (Shire/Baxalta, Aetan/Humana and Time Warner Cable/Charter Com). On the positive side, Special Situations posted gains (+0.7%) on the back of improved risk appetite and rewarding investments in sectors including basic materials, consumer and energy.

L/S equity managers (-1.3%) struggled to cope with the rotation in sectors and risk factors. Value stocks continued to rally, while momentum ones lagged behind. As a result, Market Neutral funds (-1.8%), which keep a momentum tilt, underperformed. The Long bias sub strategy delivered marginal losses (-0.3%) even if this figure hid mixed returns across managers. On the one hand, some longest bias managers outperformed thanks to their overweight allocation in value names and their structural directionality. On the other hand, underperformers suffered from cautious stances. Overall, Equity L/S funds remained positioned on defensive stocks, which performed well in 2015, and watched the rally in cyclicals from the sidelines. Finally, L/S emerging funds underperformed, penalized by their net short exposure to energy and materials.

CTAs were down 1.6% as a result of the rise in bond yields in the US and in Europe. Long term models (-1.6%) outperformed short term ones (-2.1%). All gains delivered by the bearish long term players in early April were offset when risk appetite rekindled. Their defensive stance on the fixed income (long) and energy (short) buckets suffered from the pick-up in sovereign yields and the strong oil rally (Brent up 18% in a week ahead of the Doha meeting). Losses remained nevertheless contained as positioning was markedly less aggressive in April. The FX cluster was the one positive contributor as the US dollar weakening (which mirrored a dovish Fed tone) supported short positions in the currency against commodity currencies and JPY. Short term models suffered from tactical wagers on equity indices while market trends reversed during the month.

Global macro managers underperformed 1.7%, with FX and equity clusters as the main culprit. Yet results were mixed amongst managers. Those with a long tilt towards European and Japanese equities were hit by the rise in equity volatility. As managers were positioned to benefit from low valuations and accommodative monetary policies, the unexpected BOJ’s status quo inflicted severe losses. Meanwhile, the FX bucket was detrimental as gains on longs in EM currencies against the USD did not manage to offset losses recorded on shorts in developed currencies (especially the JPY). The rally in commodity prices negatively impacted the short - albeit small - allocation to the agricultural and energy sectors. Finally, risk on positioning on the fixed income portfolio (shorts on US and UK bonds) helped to partially offset losses.

“The low growth backdrop remains a difficult environment to navigate. Analysts expect a lackluster earnings picture for 2016, with hardly any growth in developed countries. We turned overweight on CTAs as their defensive stance appears to be a good hedge against volatility and as a portfolio diversifier. Meanwhile, after the March rally, the strategy is likely to face lesser risk of reversal.” says Philippe Ferreira, senior cross asset strategist at Lyxor AM.

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