Nearing the End of a ‘Junk Rally’?


Hedge funds’ returns weakened in sympathy with this week's retreat in risky assets. Losses were mild in general, with few notable underperformers in particular. By contrast, CTAs outperformed, they recouped their earlier loss as yields and oil weakened. Funds keeping a low beta also performed well, the neutral and variable equity funds especially.

Sentiment deteriorated this week. A number of mixed economic releases failed to demonstrate any pick up in fundamentals. Macro data remained consistent with a sluggish global growth environment neither gaining nor losing momentum.

The environment since the rally started by mid-February was particularly uncomfortable for most asset managers. A binary macro backdrop and rich valuations maintained high uncertainty among investors, which prevented them from taking aggressive risks. The rally largely relied on renewed optimism on China and the global recovery, whilst the Fed was priced to remain on hold. This is a fragile equilibrium which will ultimately need to correct. Monetary policies thus remain pivotal for many assets, that of the Fed especially. Central banks’ meeting, minutes and comments are fuelling frequent asset rotations, which are challenging to arbitrage. This was yet again witnessed by the latest BoJ disappointment. 

In that context, most asset managers were reluctant to join in the rally and maintained heavily hedged allocations. As a result their returns are looking increasingly pale compared to their benchmark indices, with a growing pressure on alpha generation.

We are keeping our slight overweight on CTAs. The trend-following environment is mixed but managed futures provide a edge against volatility and a source of diversification. We currently find the greatest alpha potential in the merger arbitrage, in the variable bias L/S Equity and in the credit funds.

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