Japanese Reflation Trade Pays Off For Macro Managers In November

From FRM Investment Management


With many of this year’s themes continuing, as discussed above, November was a positive month for hedge funds. The majority of strategies were positive over the month, with very few outliers on either the positive or negative side (given adjustments for volatility). The HFRX Global Hedge Fund Index returned 0.55%.

Following several months of muted performance Discretionary Macro managers recorded positive returns in November. Many managers have maintained the Japanese reflation trade (long Nikkei, short Japanese Yen) in their books throughout the year. This paid off once again in November, with speculation in the market of further stimulus measures to come should inflationary expectations fail to materialise. The only other large position in manager’s books currently is long developed market equities. Together these two exposures represented by far the largest driver of performance, with the reflation trade in Japan in particular contributing to almost all managers. The majority of managers remain bullish on the direction for developed market equities as they see growth improving. They are however wary of the potential of tapering in December. Many believe that the Federal Reserve would like to start tapering as soon as possible; as a result many managers have steepening trades on yield curves.

Despite investors being wary of tapering, credit spreads were tighter over the month as investors continued the relentless trawl for yield. One part of the market that did display the potential of a taper was floating rate product which had significant inflows through the month. Managers holding this product benefitted as prices appreciated as a result. In general November was a positive month for Credit Long- Short managers; single stock dispersion remained high in the absence of any significant macroeconomic news flow, and was the biggest factor in manager returns. Credit Value managers will also have generated positive returns in aggregate. Moves in rates and high yield spreads offset one another leaving the carry component roughly equal to the total return.

Given the positioning of Managed Futures managers showed no significant change from October month end it is not surprising they had another strong month. This is a continuation of the recovery of Managed Futures managers post the resolution of the debt ceiling debate in the US. Once again the large long exposure to developed market equity indices was the dominant driver of the performance. The vast majority of dispersion in manager performance was as a result of the relative exposure to other asset classes. Commodity trading was more mixed throughout November; short metals, both precious and copper worked well for managers, but those trading natural gas struggled. In currencies short Japanese Yen was the largest contributor across managers, while long Euro was the main detractor; the relative sizing of each was a major factor in the overall FX attribution. At a top level positioning remains relatively unchanged with equity index exposure by far the most significant position, while interest rate exposure remains marginally long, but still in relatively small size. We continue to believe that the environment is improving for these managers, however given their positioning currently there may be more interesting ways to utilise an equity beta budget. One alternative would of course be Equity Long-Short managers. November was another good month, with managers across regions positive in aggregate. In Europe, following a strong October peripheral markets were weaker than core markets, particularly over the first half of the month with some profit taking on popular October themes potentially contributing. Manager returns in general echoed this and were slightly muted in the first half of the month, before picking up towards the end of the month. November was the middle of the Q3 reporting season in Europe; single stock dispersion was good, with a number of idiosyncratic positions that would have contributed to manager returns.

In the US performance was also positive, but again November was not a standout month. Single stock dispersion was present there in the market again as a result of earnings season continuing into the month, but it was noticeable that managers are more excited now by short opportunities than long opportunities. Exposures reflected with gross exposures increasing, while net exposures remained static. Evidence from the managers that we have spoken to suggests that this is being executed in the form of single stock shorts, not index hedges.

Given the views expressed earlier it is not surprising that we continue to feel Equity Long-Short managers will continue to be a strong alpha source in the near future. This is not dependent on a view of the general direction of markets. Absent of any significant shock we believe that equity markets should continue to trade broadly on company fundamentals, and even if negative in direction managers should be able to use their edge here to generate profits.

The Event Driven space was rather muted in November, though the natural equity beta present would have helped managers; the HFRX Event Driven Index was +60bps (HFRX M&A +20bps, HFRX Special Situations +83bps). Deal volume was 160bn USD which is towards the lower end of, but not out of line with, volumes seen this year. Again the largest transaction was in the telecoms sector, this month a 7bn USD divestiture, Emirates Telecom purchasing Maroc Telecom from Vivendi. Deals continue to be very sensible acquisitions of synergistic businesses, with few cross industry deals. Overall the environment appears to be less encouraging for managers in this space, as the number of interesting deals coming onto the market appears to be drying up. This combined with a large number of popular deals which have completed means the universe of investible deals is now smaller.

As with many strategies, Statistical Arbitrage performance was a continuation of October. Fundamental strategies performed well, particularly in the US and Europe where earnings season would have helped. By construction quantitative models, such as these, are parameterised based on historical data. When the future does not resemble the past then it is likely to be bad for these strategies. Given the environment shifted in May, and managers books can take 3-6 months to properly adapt, the timeframe of recovery is within expectations. In our central scenario above, where little shocks the markets over the coming months, we believe that Statistical Arbitrage will continue to perform well.