Tactical Trading

Sharp trend reversals in fixed income, commodities and currencies impact Systematic Traders

This month there was a wide dispersion in performance among Discretionary Global Macro managers. Trend reversals in developed-market fixed income and currencies impacted managers with long-standing positions. Managers positioned in US front-end curve steepeners, long European peripheral government bonds, long global (but especially European and Japanese) equity indices and long emerging-market currencies generated positive returns. Managers’ long developed-market duration, long gold, and long NOK vs EUR (or vs selected Asian currencies) detracted. Several markets experienced trend reversals in September, creating a difficult environment for most systematic managers, apart from only the most diversified funds. Trend-following strategies gave back a portion of their gains as losses in bonds and commodities outpaced gains in equities and currencies. Despite the Federal Reserve and European Central Bank both cutting interest rates this month, global bonds declined. In commodities, long positions in precious metals detracted as gold and silver prices declined on waning flight-to-quality concerns. Long equities positions generated gains, as did long USD exposure against JPY and EUR.

Equity Hedge

Value-momentum factor rotation painful for market-neutral strategies

At the beginning of the month there was a sharp style factor rotation from  “momentum” to “value” factors impacting many managers within Equity Hedge. This rotation was even more impactful for managers with significant exposure to the United States, as well as for those with long exposure to crowded defensive-growth investments. Short positions in underperforming consumer businesses also detracted, as did short positions in industrial, financial, and defensives stocks. Market-neutral funds were especially impacted,  generating losses in both long and short portfolios. Pointing to portfolio rebalancing, many managers have discounted the factor mean reversion as non-fundamental, and indeed the move reversed course towards the end of the month. Managers who maintained stable portfolio structure were able to recoup some of the losses coming into October. This month was the worst month for alpha in developed markets since 2010, although other regions, particularly Asia and Japan, performed better due to less crowding in positions.

Event Driven

Optimism surrounding Puerto Rico debt led to bond rally

A mixed month for Event Driven and Distressed managers, September ended with significant dispersion among sub-strategies. Against a generally positive backdrop for high yield, Distressed managers holding long positions in energy experienced increased volatility, and the sector ended the month down almost 1%.  Managers benefited from exposure to Puerto Rico as the bonds gained on anticipation of an improved negotiation plan. According to the recently approved plan, Puerto Rico would reduce a major portion of its debt thanks to a restructuring proposal filed in court by its financial oversight board. Long bond positions in PG&E and a slight recovery in Argentine sovereign credit also added to performance. Long-standing positions in the GSEs gained, with both the equity and the preferred up during the month on steps taken to transition the companies out of conservatorship. Activist managers benefited from alpha contribution from their focused long portfolios in a challenging equity market backdrop. Within merger arbitrage, average spreads remained subdued, leaving hard-catalyst specialists to seek attractive opportunities in more complex situations.

Relative Value

Extreme Repo market volatility impacts basis trades

This month, all eyes were on the US Repo market. Although most market participants had been anticipating some potential marginal increases in short-term funding costs due to a convergence of technical factors, the magnitude of the move, with a peak near 9%, was shocking. A quick and strong response from the US Federal Reserve was necessary, and was delivered in a matter of days.  This volatile episode impacted managers focusing on futures/cash arbitrage (i.e. basis trades) with a variety of performance outcomes, depending on positioning ahead of the event, as well as the level of dry powder to benefit from the basis widening. In fixed income, shorter-duration and high-yield sectors outperformed quality longer-duration sectors such as TIPs, municipal and Treasuries. Levered loans and agency MBS also outperformed. Finally, managers holding short S&P 500 volatility positions benefited from a collapse in realised volatility. The decline in volatility surprised most market participants, given the month’s multitude of geopolitical and macroeconomic events – including but not limited to the attack on Saudi Arabian crude oil production, the largest momentum unwind since 2009, the aforementioned repo crisis etc.

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September 2019 Report


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