Lyxor To Stick With Overweight in Merger Arbitrage

From Lyxor Asset Management


March has been a positive month for risk assets. As soon as mid-February, the Fed started to prepare markets for a softer stance than expected by market participants. Mid-March, it delivered at the FOMC meeting with a downward revision of growth and inflation forecasts for 2016, consolidating the rally in both equities and bonds.

Hedge funds delivered positive returns in March, supported by the bullish market environment and the dovish stance of the Federal Reserve. Year to date hedge funds remain nonetheless in negative territory , though they outperform risk assets on a risk adjusted basis. Fixed income has continued to perform lately but stretched valuations do not support aggressive positions on government bonds. In effect, 10-year bund yields are close to zero as of early April and 10-year Japanese government bond yields are negative.

In this environment, hedge fund strategies with higher directionality such as Event-Driven, L/S Credit and L/S Equity outperformed. In parallel, strategies that are more defensive such as CTAs and Global Macro underperformed. On a YTD basis however, CTAs continue to be in positive territory since their defensive positioning was highly protective at the beginning of 2016. The merger arbitrage strategy is also in positive territory year to date.


Hedge Funds Defensively Positioned

Going forward, we note that the market rally is already showing signs of fatigue as central banks’ medicine is becoming less effective. Hedge funds remain defensively positioned with an equity beta close to 15% which is far below usual levels. As a result they should continue to outperform risk assets in the coming weeks.

In terms of investment recommendations, we maintain our overweight stance on merger arbitrage. Recent developments demonstrated its all weather properties: the strategy was resilient when markets were down, and it was up when markets rebounded. We are also overweight L/S Equity funds with a variable bias which can navigate this turbulent environment. Meanwhile, we upgraded L/S Credit to neutral as the asset class is enjoying tailwinds with the rebound in commodity prices and ECB purchases of corporate bonds. Finally, we are neutral CTAs but with a positive outlook and remain underweight special situations funds which are more sensitive to market directionality.