Lyxor’s Senior Strategist Philippe Ferreira explores which alternative strategies have (or haven’t) weathered the Covid-19 storm, why investors are cautious about coming back to the alternatives universe, and why there needs to be patience about a ‘return to normal’.
How have alternative strategies performed in the midst of the crisis?
We are observing wide dispersion in performance, not only between strategies but also within the same strategies. CTAs have shown their ability to withstand market shocks due to their excellent risk management, which took the form of a swift reduction in long equity positions. Achieving a performance close to zero in March, these strategies have proved their potential for portfolio diversification. Conversely, because of their high market beta or value bias, Special Situations and L/S Equity have suffered during the crisis. Between these two extremes, merger arbitrage and long/short credit strategies stood up well at the start of the crisis thanks to their modest sensitivity to risk assets. However, at the time of the market rout in mid-March, these two strategies suffered considerable losses (-7.2% and -6.7% respectively in March, according to Lyxor data), due to market dislocation. This caused a dramatically widened spreads in the risk premiums to which these strategies were exposed (M&A arbitrage spreads and high yield credit spreads). It should be noted that merger arbitrage strategies have recovered strongly (+4% in April) with the decrease in systemic risk in response to the actions of the US Federal Reserve at the end of March. Besides, global macro strategies have recorded varied performances, depending on how fund managers were positioned on the market shocks. When the markets fell, systematic strategies fared better than those that were purely discretionary (-1.9% against -8.5% in March).
Are investors tending to return to the alternative investment universe?
European alternative strategy UCITS experienced a sharp outflow of funds in March (EUR -20.5 billion). Long/short credit strategies (EUR -5.5 billion), always vulnerable in dislocated markets, global macro (EUR -2 billion) and long/short equity (EUR -4.6 billion, including market neutral strategies as well), suffered the heaviest outflows in March. The present situation urges caution on investors. In fact, they are proving slow to participate in the rally we are now witnessing, for fear of a second wave of market correction. They prefer to take refuge in defensive strategies such as merger arbitrage and CTAs, which have seen least disinvestment. Market neutral long/short equity strategies, which have in the past been defensive, generally proved a disappointment during the market shocks at the end of 2018 and early 2020.
Can we expect things to return to normal, and in what time-frame?
From an economic perspective, a return to normality will be slow in coming and some sectors (transport, entertainment, hotels and catering) will remain under pressure for a long time. At this stage, placing bets on a prolonged rally seems risky and optimistic, unless a tried-and-tested treatment for COVID-19 appears soon, which would allow economies a speedy return to normal. In this context, alternative strategies could turn out to be winners if we bear in mind that their long/short approach reduces their market sensitivity, and that central bank intervention will help limit systemic risk.