Weekly brief

Which Alternative Strategy Amid the Trade Confusion?

Renewed trade tensions sent markets into a tailspin at the end of last week. President Trump said he would place an initial 10% tariff on $300bn of additional Chinese goods, effective on September 1st. Such tariffs would cover final goods, potentially hurting the last U.S. growth engine: consumers. The deadline leaves a narrow negotiation window in August, but it is hard to imagine how this can be sorted out. The damage is done, and China will probably retaliate. To add to the confusion, President Trump later said he is “open to delaying or halting the 10% tariff”. Amid sluggish summer trading volumes and looming Brexit deadlines, investors will probably sell and go away before considering taking advantage of lower risk asset prices. Meanwhile, bond yields reached record lows in Europe and will probably test new lows in the coming weeks.

 

In such a confused context, low beta hedge fund strategies are set to outperform. Even though the latest trade announcements came as a surprise to us, our views were already geared towards defensive strategies: O/W Merger Arbitrage and Market Neutral L/S. We also reiterate our O/W stance on L/S Credit and EM Global Macro, as a stance in favor of carry strategies in a low bond yield environment. Meanwhile, high beta strategies such as Directional L/S Equity and Special Situations are likely to feel the brunt of the equity market reversal. With regards to CTA and Global Macro, the former is set to post gains on long fixed income positions and reduced exposure to equities while Systematic Macro strategies are likely to be under pressure due to short fixed income positions.

 

In terms of recent performance, CTAs extended their winning streak in July, up 2.9%, bringing the year-to-date performance to 11.2%. Merger Arbitrage and Market Neutral L/S underperformed in July (0.6% and 0.2% respectively) in a context where the MSCI World was up 2%. In such market conditions, volatility turns out to be more important than usual. As a result, we look at the extent to which adjusting for volatility changes the ranking in hedge fund strategies based on our Peer Groups. From that perspective, L/S Credit turns out to be the best performing strategy and CTAs fall in the rankings. The performance of Directional L/S Equity is also less attractive on a risk adjusted basis, while Merger Arbitrage is a touch better.