Despite colossal headwinds from trade tensions, the Brexit deadlock and the manufacturing recession, asset prices have proved incredibly buoyant so far this year.
Despite colossal headwinds from trade tensions, the Brexit deadlock and the manufacturing recession, asset prices have proved incredibly buoyant so far this year. Equities are recovering from the August drawdown and are approaching the same record levels from late July. The asset class could deliver the highest yearly returns since 2013 (MSCI World +18% year-to-date). Meanwhile, global bond benchmarks are on track to deliver their best year since 2000 (Barclays Global Aggregate +8.8% year-to-date).
In this context, hedge funds are also posting robust returns. The Lyxor Global Alternative UCITS Peer Group was flat in August, leaving year-to-date returns close to +5% in USD terms. Performance in recent months was led by CTAs, which delivered impressive returns (+3.7% in August; +16.2% year-to-date as of September 3). Considering the higher volatility of CTAs, the picture on a risk adjusted basis is slightly different, with L/S Credit leading the pack with an annualized Sharpe ratio of 6 so far this year (vs. 3.3 for our Global Hedge Fund Peer Group).
But as we head into the last quarter of 2019, we turn more defensive. US trade tariffs are set to increase from 25% to 30% on 250bn USD of annual imports from China starting October 1. Manufacturing new orders continue to signal a contraction, and the Michigan survey signals an erosion in consumer confidence which might hurt private consumption, the last engine of US growth. The risks are thus highly asymmetric in our view.
In this context, hedge funds might help to cope with the continuing uncertainty. Merger Arbitrage and Market Neutral L/S are attractive despite their underperformance so far this year. We also reiterate our O/W stance on L/S Credit and EM Global Macro, as a stance in favor of carry strategies in a low bond yield environment. Meanwhile, high beta strategies such as Directional L/S Equity (U/W) and Special Situations (N) are likely to feel the brunt of the equity market volatility. With regards to CTA and Global Macro (N), we are reluctant to add to the former after the recent rally. Yet, CTAs do provide protection against a reversal in stock prices and/or adverse Brexit developments thanks to their short GBPUSD positioning. Finally, within Global Macro, we prefer EM-focused strategies (O/W), working off the expectation that the Fed will materially ease monetary policy in the coming months. We anticipate two rate cuts from the FOMC before the end of the year (September 18 and December 11).