By Hedge Fund Insight staff
At the beginning of the last quarter Deutsche Asset & Wealth Management’s Hedge Fund Advisory Team advised an overweight in equity market-neutral and an underweight in distressed investing strategies. Both have been good calls in the short period since. Here we catch up with Tim Gascoigne, Head of Liquid Alternatives – Hedge Funds, and ask for updates on views on both investment strategies.
Is equity market-neutral likely to continue to outperform?
We will probably see continued equity-market volatility in the United States, as investors worry about the timing and magnitude of an interest-rate increase, a potentially stronger U.S. dollar and its impact on corporate earnings. We expect this will maintain a low level of correlation across equities. We continue to hold a positive view on equity market-neutral as the trading environment remains favorable for arbitrage -orientated equity strategies, with dispersion between stocks, sectors and style factors likely to remain a key performance driver. Equity-market liquidity is also healthy after reduced levels over the summer period. Furthermore, the third-quarter earnings season should provide further reasons for differentiation between individual stocks and market sectors. The increased focus on fundamentals as a determinant of equity valuations, combined with currency and commodity trends, should provide many opportunities for managers to find profitable trades within equity-market-neutral strategies.
Are there ways to manage a long-biased approach in the current environment?
We would suggest a close monitoring of equity long/short allocations and prefer approaches with a low net exposure. With regard to geography we feel comfortable with current levels of risk in Europe but would continue to avoid long-biased emerging-market strategies. Within event-driven strategies, we suggest avoiding the more directional equity-special-situations funds, which can be concentrated on a few events and exposed to any unwinding of risk. Within credit, we would focus on managers that risk manage their overall allocations effectively, focusing on high-quality credits on the long side and keeping smaller positions on the short side.
Will market volatility create opportunities?
For discretionary macro managers, investors’ preoccupation with the Chinese growth slowdown represents an opportunity. As market participants reassess its implications for both consumer demand and global inflation, this impacts valuations across yield curves , exchange rates and relative equity sector preferences. For Commodity Trading Advisors (CTA), while we still await the re-emergence of significant asset-class trends that drive the majority of their returns, elevated volatility sets the scene for gains. With regard to the short-term approaches that feed off healthy intraday volatility, their mean-reversion and break-out models are expected to be well-positioned to generate strong returns.
Could there also be good returns in the distressed sector?
Our view is that the current low default-rate environment provides very little opportunity to earn substantial risk premia here. We believe that default rates are likely to stay low for the foreseeable future as companies continue to have access to capital markets to refinance or roll-over maturing debt. However, we expect to see more opportunities within the energy sector due to oil-price volatility forcing companies to restructure their debt.
Can a core portfolio benefit from auxiliary strategies within equity and credit markets?
We suggest a core portfolio built on the three pillars of liquidity, a positive correlation to higher volatility and an ability to perform whether the market is going up or down. This would be comprised of equity-market-neutral, global-macro and CTA strategies. Around this, we would have strategies operating within equity and credit markets where the underling liquidity profile of their assets and the tendency of this to change is an important determinant of strategy selection.