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Lyxor Weekly Brief - L/S Equity Shows Resiliency as Market Momentum Falters

Over the recent days, hedge fund performance took a small hit on the back of adverse market developments and trend reversals. Higher risk aversion was not related to specific earnings miss or macro disappointments. Instead it looked liked investors were securing gains after several quarters of strong performance for risk assets. As the earnings season is coming to an end and the US tax reform blueprint is likely to be less ambitious than expected, investors have a higher tendency to err on the side of caution.

The rise in risk aversion looks like to be short lived and contained overall. Last week, European and Japanese stocks underperformed US equities; high yield credit spreads widened and, curiously, bond prices fell along with equities. Trend reversals across asset classes and the positive correlation between equity and fixed income returns contribute to explain why CTAs underperformed last week (-1.9%). They dragged down the Lyxor hedge fund index (-1%). Meanwhile, Global Macro strategies (-1.3%) also suffered on the back of the underperformance of European equities, dollar depreciation and falling energy prices.

On a positive note, L/S Equity funds showed resilience. The strategy outperformed last week (-0.4%) as some market neutral funds managed to deliver positive returns. From a geographical perspective, Asian and U.S. managers outperformed. Several variable managers in our sample also had de-risked portfolios over the course of October, allowing them to post limited losses. For instance, we saw one manager decreasing its net exposure to equities from 40% early October to 20% early November.

With regards to Event-Driven strategies (-1%), merger arbitrage underperformed special situations despite the fact that it has structurally a much lower beta. Some merger funds were impacted negatively by widening deal spreads at core holdings such as Time Warner vs AT&T and NXP semiconductors vs. Qualcomm. Finally, recent market developments do not alter our recommendations: a preference for Global Macro (overweight) to CTAs (neutral) and a preference for Event-Driven (overweight) to L/S Equity (neutral). We also maintain an overweight stance on fixed income arbitrage.

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