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Lyxor: Hedge Funds Recovered From Equities Sell-Off

Lyxor's Cross-Asset Research team's weekly research report sees the asset manager neutral to negative on trend-followers.

"We are more skeptical regarding trend-followers in the coming weeks. Multiple trends broke during the selloff. While few assets now remain stretched, a majority could be range trading. We see reduced reversal risk, but many false starts. The shock was strong enough to force a profound reshuffling of their exposures.

In aggregate, CTAs cut their long equity and commodity exposures by half, but maintained their short USD (especially vs. EUR) and their short U.S. bonds. They neutralized the bulk of their long European and Japanese Bonds.

While we acknowledge their risk profile is considerably safer (which tells us that the deleveraging is behind), they would not fully benefit from the recovery. Moreover, the market structure will take time to settle down and allow for new trends to shape up. Historically, CTAs struggled after most large selloffs. We keep our neutral stance, with a negative watch" said the report.

Lyxor also sees challenges for discretionary equity hedge funds.

"Managers will not enjoy the extra arbitrage potential for long. By contrast, we expect that the current stock re-correlation will last, with a common set of drivers likely to stay on the radar (including rates, inflation, dollar). Distracting markets from companies’ fundamentals, it will make bottom-up selection more challenging. The cold shower on the U.S. earnings season was telling: strong earnings and revenues were disregarded, while returns after EPS announcements largely resulted from broader market moves."

That said, the firm does see opportunities in the space.

"Conditions are still supportive. Stock correlations remain moderate, reflecting a rich set of themes that will unfold in the coming months, including the tax reform, fiscal spending, a capex revival, and corporate activity. Moreover, most diversified funds maintained their exposures during the selloff and managed to generate alpha. We keep our preference for deep value funds and our underweight on quant/neutral funds."