Man FRM Early View: March 2017

April, 2017

Hedge funds generated positive returns on average during March, with the best performance generally coming from European focused Equity Long-Short, EM focused Macro strategies and some Relative Value strategies. U.S. focused Equity Long-Short and Credit specialists produced mixed performance, and Managed Futures managers generally saw losses.

In Equity Long-Short, the rally in European markets helped managers with a larger allocation to this region, and unsurprisingly those with higher beta performed better than their market neutral peers. The profit-taking days towards the end of the month hurt managers in all regions despite being driven by concerns over the ability of Trump to deliver more market-friendly reforms in the U.S. Despite mixed performance, we haven’t yet seen any U.S. Equity Long-Short managers with notable negative performance. Asian managers were generally positive as valuation metrics continued to normalize across the region.

Discretionary Macro managers exhibited positive performance overall in March, led by EM focused Macro managers. The resurgence in EM risk markets on the year, with the MSCI EM Index at +12% in Q1 and EM FX broadly higher versus the USD, has provided a robust trading environment in both Latin America and Asia ex-Japan, and Macro managers have generally capitalized. Long MXN versus USD was noteworthy as the peso rallied +7% on the month in light of Trump’s more subdued rhetoric on protectionism. Contributions to global growth have been supported by a broad base of fundamental indicators (U.S. domestic demand, wage growth, as well as stronger global trade) which suggests the underlying environment for EM assets remains supportive in our view.

Within developed markets, price action in March was a bit bumpier, with the DXY Dollar Index finishing -1% on the month and U.S. Treasury 10 year Rates trading in a wide 25bps range, peaking ahead of the Federal Open Market Committee (“FOMC”) mid-month meeting, and then rallying to finish the month unchanged. Fed President Yellen delivered a more dovish statement at the March FOMC meeting, which fueled the U.S. Treasury rally and the tightening of inflation break-evens, and some Macro managers suffered losses from paid U.S. Rates positions. European Rates, on the other hand, were slightly higher, led in the intermediate sectors by German Bunds, and as concerns about the French political situation receded slightly. Many Macro managers benefitted from the outperformance of European Equities over the U.S. during March.

One other recent development in the Macro space worth noting is the significant tightening of the cross-currency basis swap globally, indicating an increase in the availability of global USD liquidity. USD/JPY 3-month basis swap in particular has tightened from 91bps in November to 30bps currently. Recent weekly security flow data from the Japan Ministry of Finance have revealed notable inflows into Japan money market instruments, many of which have then been subsequently swapped back into USD as the prospect of U.S. bank deregulation has helped loosen U.S. bank risk appetites.

In Managed Futures, Equities were the only positive sector in March, with long positions in Europe and Asia gaining the most. FX, Commodities and Fixed Income were all marginal detractors. We believe the biggest area of risk for Managed Futures remains Equities where managers are net long in North America and Europe. FX is the second largest area of risk, with net short positions in JPY, GBP, EUR and CAD[1]. In Rates, the programs are close to flat while in Commodities there has been a move to a slight net short bias which has occurred in the latter half of the month.

Corporate Credit was muted with most managers posting flat to negative returns for the month. Credit Long-Short managers generally held up better than outright Distressed managers. After a noteworthy 12-month rally for commodity-related Credits, there was some give back in March as crude oil was lower driven by a rise in inventories and increased production. Also, the recent developments in Puerto Rico caused mark-to-market losses across most PR obligations. A long-term fiscal plan was approved in March that indicated smaller debt service capacity than previously anticipated by creditors.

Structured Credit manager returns across the peer group were mixed with minor gains from principal and interest payments. CLO mezzanine debt continued to perform well in March benefitting managers with larger allocations to the sector.

The Event strategy backdrop in the first quarter has included expectations for business-friendly policy initiatives to fuel the corporate activity opportunity set, but March has had a somewhat more mixed tone, with U.S. stocks and High Yield Bonds moving sideways or down as a rapidly developing landscape is shaping expectations. For example, at a high level, the nuts and bolts of healthcare reform in the U.S. took center stage in March as an indicator of the new administration’s ability to enact policy in such a noisy political environment.

More specific to the environment for deal flow, March reports of Deputy White House Counsel, Makan Delrahim, being nominated to lead the Justice Department Antitrust Division indicates that more clarity on the outlook for antitrust policy should be imminent. Other notable themes have included the role of supportive debt markets in encouraging Private Equity sponsors to deploy considerable cash balances in deals, and the impact of Chinese capital controls in meaningfully reducing the volume of cross-border deals YTD versus 2016.

It was a mixed month for Statistical Arbitrage managers. Fundamental strategies generally did well, while there was much more dispersion in Technical and Futures based strategies. Fundamental strategies had a robust month, especially in Asia where a variety of factors worked particularly well, including both Value and Momentum, which has historically signified a more favorable environment for Quantitative Equity strategies. Europe and the U.S. were slightly more mixed. Futures strategies that have a higher Momentum component were negative, but shorter term strategies generally performed better.