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Prefer CTAs to Market Neutral L/S

Risk appetite faded over the recent weeks, in a context where investors appear to be securing gains achieved during a strong year for equities. The MSCI World still managed to climb higher in November, for the thirteen month in a row, fuelled by U.S. and Japanese indices. European equities were down in local currency, negatively impacted by currency appreciation vs the U.S. dollar. EM equities also suffered as the tightening of liquidity conditions in China is fuelling expectations of economic deceleration. The rally in HY credit is also showing signs of strain on both sides of the Atlantic.

In the hedge fund space, trend reversals proved harmful earlier in November. But CTAs still managed to outperform last month as a result of their long allocations to European fixed income and short USD stance. The Lyxor CTA Broad index was up 0.8% in November while the Lyxor Hedge Fund Index was up 0.3%. Meanwhile, Event Driven underperformed (-1%) as some deal spreads that rank high in merger arbitrage portfolios, such as Time Warner vs AT&T, widened.

Interestingly, and in line with our expectations, CTAs outperformed Market Neutral L/S. These strategies have a very low correlation to the MSCI World over the long term and are generally looked after by institutional investors for risk mitigation purposes. They received the largest cumulated inflows over the last two years.

In terms of investment recommendations, we continue to express a preference for CTAs over L/S Equity Market Neutral (see link) for several reasons: i) CTAs are structurally more diversified than Market Neutral L/S in terms of asset classes traded and geographical exposure. The corollary of this is that ii) Market Neutral L/S are more sensitive to sector/ factor rotations in equities considering their leveraged positions; and finally iii) Market Neutral L/S have recently been quite aggressive in terms of positioning: long momentum on the one hand, and short quality/ low beta stocks on the other hand. This has been a source of losses in a market experiencing trend reversals and looking for safety with quality stocks.