Global Macro

Discretionary global macro

Discretionary global macro strategies generated positive performance during the third quarter of 2020, further adding to positive gains recorded in the first half of the year. Emerging market (EM)-focused managers continued to benefit from several themes observed in the prior quarter, namely strong performance in long interest rates and tactical currency trading. Asia-focused managers enjoyed economic recovery in the region, with the increasing strength of the Chinese renminbi driving performance. EMEA-focused managers benefited from sovereign and corporate credit positions. Quasi-sovereign credit positions in oil-producing regions were also additive to strategy performance during the third quarter. Developed market (DM)-focused managers observed mixed performance over the period. In the first half of the quarter, more bearish managers were hurt by the seemingly never-ending rally in U.S. equities. Short equity losses were softened later in the quarter, as the risk sentiment reversed. Managers within this space continued to trade currencies tactically over the quarter, but there were few clear winners apart from the general weakening of the U.S. dollar.

CTA/Managed futures

CTA/Managed futures strategies generated marginally negative performance over the quarter, deepening year-to-date losses. Managers employing medium- and longer-term models continued to struggle over the period. Managers within this space who aggressively positioned themselves started the quarter very positively, benefiting from the risk-on environment. However, these gains were reversed into September, as the risk sentiment changed. Long equity positions and short U.S. dollar exposures detracted severely from strategy performance over the third quarter of 2020.

Systematic macro

Systematic macro strategies saw positive returns during the third quarter of 2020, although this was not enough to offset the significant drawdown they experienced earlier in the year. The majority of these gains were concentrated in July, as aggressively positioned managers were able to benefit from the risk-on environment. Strong performance was recorded in equity indices, where long positions across several developed and emerging market indices generated gains. In currencies, the U.S. dollar weakness benefited several DM currency pairs, particularly the British pound, which was one of the best-performing currencies in July. The last month of the quarter proved to be much more challenging for many strategies as the risk rally stopped. Managers with a higher tilt to long fixed-income positions were able to minimize underperformance more effectively.

Volatility – tail risk

Tail-risk strategies generated negative performance during the third quarter of 2020, as these strategies continued to give away some of the strong gains generated earlier in the year. Currencies detracted significantly, as the dollar spot index had its largest monthly drawdown in the last five years, as risk sentiment moved against the U.S. dollar. September saw a reversal in the previous months’ trends of short U.S. dollar and long precious metals, as equity markets sold off and implied volatility spiked to its highest point since June. Defensively positioned managers benefited from the risk-off sentiment toward the end of the quarter, with the long U.S. dollar crosses, particularly versus the euro, short commodity and equity positions.

Fixed income relative value

Fixed income relative value funds generated strong positive performance over the period. The bulk of the gains for the peer group were recorded early in the quarter. Managers more active in investment grade and high-yield credit strategies enjoyed the best performance over the quarter supported by the Fed asset purchase program. Bond basis trading was profitable, but a more muted contributor during the quarter as volatility remained compressed. European opportunities have started to increase but contributions have been limited. Mortgage, volatility and discretionary macro sub-strategy allocations were profitable during the quarter, adding to overall gains.

Equity

Fundamental Long/ Short

The third quarter proved to be a profitable period for long/short equity strategies (HFRI Equity Hedge Index +6.0%), with the majority of funds now comfortably in positive territory for the year. The strategies benefited from upward-trending equity markets as optimism surrounding tackling the Covid-19 crisis helped contribute to August highs. However, this enthusiasm did taper off in September as a combination of increasing numbers of Covid-19 cases and resulting lockdowns, a stalemate in U.S. stimulus discussions and skepticism surrounding U.S. technology valuations contributed to a pull-back in equities. There was modest performance dispersion over the period driven by factor, country and market-beta exposures.

Factor exposures were again responsible for divergent performance over the period, but these were not as sizeable as in the second quarter. Yet again, exposure to momentum and growth were strong contributors, but we did see a partial rotation to value during September. This in part contributed to a junk rally, which proved a headwind for some short portfolios. Despite this, alpha generation was positive across all regions. From a sector perspective, funds with overweight exposures to technology and consumer discretionary stocks were again amongst the top performers, despite posting negative returns in September amid the sell-off in technology. Additionally, managers with exposure to renewable energy stocks benefited from strong performance within the space. Sector specialists and multi-PM funds again delivered attractive returns. Low net- and market-neutral funds on the whole underperformed their longer-biased peers, but many delivered high-quality returns driven by alpha from stock picking. Systematic funds tended to underperform fundamentally-oriented strategies. While most managers tended to post muted returns over the quarter, those with faster trading time horizons, particularly in their technical models stood out.

From a regional perspective, U.S.- and Asian-focused funds were generally the top performers. Within Asia, Greater China long/short funds continued their strong run with the strategy benefiting from rallying equity markets (on the back of economic data indicating an ongoing recovery) and a productive earnings season. Elsewhere within emerging markets, Latin American and emerging Europe-focused funds were largely negative. In Latin America, Covid-19 continues to weigh heavily on the region. The combination of oil price weakness, volatility of the Turkish lira, election protests and uncertainty over the U.S. election and resulting foreign policy were headwinds for managers investing in emerging Europe. European equity markets were largely negative over the quarter but most long/short funds investing in the region delivered positive returns with managers indicating that the second-quarter earnings season resulted in good stock dispersion.

Gross and net exposures trended upward over the period and in the run-up to the U.S. election, most prime brokerage desks indicated that risk levels were towards the high end compared to historical levels. European managers have been more cautious in terms of gross leverage than their U.S. and Asian counterparts due to concerns around the longer term headwinds from Covid-19. Crowding remains elevated and is a concern as crowded stocks are potentially more vulnerable to de-leveraging events. Despite this wariness, crowded stocks continue to perform well, with the various hedge fund VIP indices outperforming the broader market. Pleasingly, alpha generation remains robust with many managers happy with the recent earnings season and the fact that fundamental, bottom-up research was by and large rewarded on both sides of the portfolio. On the whole, managers are optimistic on the outlook for stock picking and are looking forward to the U.S. election being behind us with this being another major macro event that has dominated markets in recent weeks. Managers are hopeful that following the result, the market remains conducive to stock picking and dispersion persists.

Systematic quantitative

Among systematic quantitative strategies, performance was positive for the third quarter 2020. Managers benefitted from the continued heightened volatility in markets from the second quarter. By model type, managers generally saw success across both technical and fundamentally based models, although the more idiosyncratic fundamental models had trouble navigating the changing market environment. A sudden bout of volatility in September, however, hurt equity arbitrage strategies, particularly those with longer-term trading time horizons.

Event driven

Risk arbitrage

As markets continued to rally from their post-pandemic lows in March, an uptick in both CEO confidence and corporate activity have encouraged trends that helped drive positive idiosyncratic returns for all event driven strategies during the third quarter of 2020.

The pick-up in announced M&A deal volumes is a tailwind for risk arbitrage strategies and creates fresh capital deployment opportunities. There were 15 deals worth $10 billion or more announced during the third quarter of this year.¹ Overall, announced M&A volumes reached $1.1 trillion — the strongest third quarter for M&A volumes ever.² The rise in SPAC-related M&A activity is also unprecedented, with year-to-date SPAC acquisitions the highest they have ever been, totaling $84 billion.³ This activity has benefited risk arbitrage managers that grew their allocations to this booming asset class over the summer in place of more traditional M&A. As we entered November, there were 178 SPACs with more than $62 billion of capital raised seeking business combination and an additional 64 SPACs that filed to IPO in the near future.⁴ The potentially limited downside and attractive upside potential upon deal announcement offered by the SPAC structure make it an attractive event-driven trade, and market-favored deal announcements from respected sponsor groups drove appreciation across the SPAC universe in the third quarter.

Activist

The ability to be their own catalyst for change was a positive for activists or managers that selectively use activism in the third quarter. Many managers publicly disclosed new activist stakes in companies as we saw a return to traditional company engagement, running the full spectrum from board involvement in companies navigating implications of Covid-19 to Third Point’s “dare to be great” letter to Disney. The market will typically reward this type of engagement, which creates strong alpha-generation opportunities.

Value with a catalyst/Multi strategy

Elsewhere, value-with-a-catalyst (VWC) managers benefited from beta as popular Covid-19 recovery/beneficiary plays continued to appreciate. Multi-strategy managers saw more muted — but still positive — performance given their defensive and diversified postures, but generally protected capital well during September’s mini market sell-off.

Alternative credit & fixed income

Credit – value

Long-biased performing corporate credit strategies generated strong returns in the third quarter, building on momentum from the previous quarter. Performing loans broadly benefited from the economic recovery engendered by fiscal stimulus and pent-up demand for goods and services due to the spring shutdowns. Key sectors that drove performance were fitness and restaurants with gains in several big-name companies within these spaces, including fitness centers Equinox and Planet Fitness, as well as restaurants Portillo’s, and Cooper’s Hawk for one manager. Another manager generated positive contribution from first lien term loans in Gogo and the floating of shares in Hycroft via SPAC.

Credit – trading

Long/short credit trading managers ended the third quarter in positive territory, with particularly strong performance in July and August. In a continuation from the previous quarter, most strategies, including commercial mortgage-backed securities (CMBS), residential mortgage-backed securities (RMBS), collateralized loan obligations (CLOs), high-yield and investment-grade derivative tranches, contributed positively. Most of the gains came from spread tightening across pro-risk positions.

Credit – distressed

Stressedhttps://prd-cdn.aberdeenstandard.nethttps://prd-cdn.aberdeenstandard.net/distressed credit managers continued to rebound in the third quarter against a backdrop where the JP Morgan U.S. HY Index was up +5.2% and the EMBI TR Index was up +2.3%. over the third quarter. Most of the positive performance came over the first half of the quarter, as bond and loan prices began to stall over the second half. Defaults slowed during the third quarter but remain elevated. The largest defaults included Noble Drilling ($3.4 billion in bonds and loans), Denbury Resources ($1.8 billion), and Oasis Petroleum ($1.6 billion). Outside of energy, managers benefited from performing credit positions in long-dated unsecured bonds of investment-grade companies heavily impacted from Covid-19. These cap structures included Delta, Boeing, and General Electric. PG&E was another common contributor, although managers began to monetize the position in July after its restructuring was completed. Meanwhile, performance was somewhat mixed for managers participating in retail restructurings such as Neiman Marcus. AMC Entertainment was another detractor. In emerging markets, Argentinean and Ecuadorean sovereign bonds rallied significantly in early July as both countries restructured its debt. The exchanged bonds began to retrace some gains by September, perhaps due to technical flows and a lack of near term catalysts.

Credit – structured credit

The third quarter broadly saw a continued recovery in the structured credit markets, supported in the background by monetary/fiscal policy, low mortgage rates and economic stabilization after the first wave of Covid-19. Structured credit portfolios were generally positive on the long side, although hedges tended to detract from returns over the quarter.

In RMBS, robust housing fundamentals (house price increases and decreasing delinquencies) together with positive technicals (limited supply coupled with demand) led to pricing gains across RMBS 2.0, as well as legacy securities. Despite lighter trading volumes over the summer, a series of RMBS 2.0 new issuance came to market and was well-received, including private-label 2.0, CRTs, non-QM RMBS and RPL transactions. Covid-related forbearance rates plateaued and reduced significantly over the summer, alleviating investor concerns.

In CMBS, spreads were also stable over the summer, with demand for long-duration assets benefiting higher-quality securities such as Agency CMBS and AAA conduit CMBS. Good performance also came from the multi-family sector in particular, where rent collection has remained strong. Despite the impact of Covid-19, the demand for affordable housing remains robust and well-managed properties continued to see steady rent collection. In contrast, troubles continue to brew ahead for commercial office property in gateway cities. For example, Manhattan office leasing volume are reported to be lower by 21% year over year. as Additionally, certain retail malls where footfall has dropped significantly face challenges ahead.

In CLOs, spreads in the junior debt tranches tightened in the first two months of the quarter, but leaked wider in September due to heavy new issuance volumes and as underlying loans moved sideways and high yield sold off modestly on the back of outflows from mutual funds and ETFs. Expectations of credit default have moderated since the start of the Covid-19 crisis, with JP Morgan lowering their default projections to 6.5% and 4% respectively for bonds and loans.

Relative value – MBS/ABS

Mortgage derivative portfolios entered the quarter against the backdrop of a high refinancing / prepayment environment, with the primary mortgage rate dropping to 2.99%. Both conventional and Ginnie Mae speeds recorded a jump in July on the back of elevated refinancings, but also, in the case of Ginnie, due to continued bank buyouts. Generic spreads widened initially, but tightened again later in the quarter as prepay speeds stabilized. Portfolios overall generated positive carry from their mortgage derivative strategies, with asset selection focused on lower loan-to-value ratios and seasoned vintages proving to be a defensive choice. Given elevated spreads, managers still see good opportunity to acquire portfolios of storied securities with room to earn solid carry, and for spread tightening. Managers that trade in adjacent sectors, such as mortgage REITS and originators, also benefited from their improved share prices due to record origination volume and profits.

Relative value – convertible relative value

Convertible relative value strategies performed well during the third quarter, continuing the strong performance rebound that started in April after the large March losses. Returns were once again driven by a combination of strong new issuance trends and the general increase in asset prices due to strong earnings momentum and forward-looking expectations. Other positively contributing factors include heightened levels of single-name equity volatility (tactical gamma trading opportunities) and M&A activity. Continued strong issuance (YTD global convertible issuance hit a decade high of $132 billion, surpassing the first nine months of 2019 by 50%)⁵ provided managers with an active pipeline of trading opportunities. Managers were able to see quick initial gains in secondary market trading with many new issues “priced to sell.”. For example, in September, several fast-growing technology companies issued in the converts market, including Shopify, RingCentral and Medallia which were all well received. Elevated levels of single-name volatility allowed managers not only to benefit from an expansion in valuation, but also to monetize the implied realized spread via active gamma trading. Overall, managers expect a healthy level of idiosyncratic volatility to continue, in response to the uncertainty created by the impact of Covid-19 on the economy, the U.S. election outcome, fiscal stimulus and other geopolitical issues.

Specialty finance

Specialty finance strategies generally report performance with a quarterly lag. However, the direction of quarterly valuations suggests that there is a wide range of performance impact from the Covid-19 disruptions. On the one hand, aviation-leasing strategies focused on passenger travel have experienced significant disruption, but on the other hand, aviation strategies focused on the cargo segment have been beneficiaries of reduced passenger flights and strong e-commerce demand. Similarly, U.S. residential development strategies continue to perform strongly on the back of historically low mortgage rates and strong house price increases. The healthcare royalty sector has also continued to perform as expected. European commercial non-performing loan strategies have seen mixed impact — valuations could come down from here especially for hotel and leisure-related real estate assets, however the Covid-19 shutdown could create a greater pipeline of distressed assets in the coming months.

Reinsurance

It has not been an easy three-quarters of the year for reinsurance strategies. It is estimated that insured global catastrophe losses stand at about $54 billion YTD (below $75 billion full-year 2019 estimates). The losses stem from a range of primary and secondary perils throughout the year, including Australian storms, U.S. severe convective storms, several smaller-scale Atlantic hurricanes and West Coast Wildfires, together with losses from Covid-19. At these loss levels, both the reinsurance and retrocession sectors will likely experience some impact and experience a moderate level of trapped capital into year-end. However, barring further significant, large-scale events, well-constructed portfolios should be able to generate a positive high-single digit net return for the year.

It is interesting to note that Covid-19 has created a new set of challenges for the industry, leading to dispute around insurer liability as well as a tightening up of policy language to exclude pandemic-related losses in future contracts. Together with a reduction of investor capital overall due to trapped capital and fund liquidations, there is expectation that the January 2021 renewals will experience hardening market conditions again in favor of capital providers.

IMPORTANT INFORMATION

Hedge funds use sophisticated investment strategies that may increase investment risk in your portfolio. Among the risks presented by hedge fund investments are: the use of unregistered investments, which may make it difficult to assess the performance of the holding; risky investment strategies, which may result in significant losses; illiquid investments that may be subject to restrictions on transferability and resale; and adverse tax consequences.

Alternative investments involve specific risks that may be greater than those associated with traditional investments; are not suitable for all clients; and intended for experienced and sophisticated investors who meet specific suitability requirements and are willing to bear the high economic risks of the investment. Investments of this type may engage in speculative investment practices; carry additional risk of loss, including possibility of partial or total loss of invested capital, due to the nature and volatility of the underlying investments; and are generally considered to be illiquid due to restrictive repurchase procedures. These investments may also involve different regulatory and reporting requirements, complex tax structures, and delays in distributing important tax information.

Indexes are unmanaged and have been provided for comparison purposes only. No fees or expenses are reflected. You cannot invest directly in an index.

Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).

High yield securities may face additional risks, including economic growth; inflation; liquidity; supply; and externally generated shocks.

Derivatives are speculative and may hurt the Fund’s performance. They present the risk of disproportionately increased losses and/or reduced gains when the financial asset or measure to which the derivative is linked changes in unexpected ways.

Trading in commodities entails a substantial risk of loss.

Investments in asset backed and mortgage backed securities include additional risks that investors should be aware which include those associated with fixed income securities, as well as increased susceptibility to adverse economic developments.

The use of leverage will also increase market exposure and magnify risk.

Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.

Companies mentioned for illustrative purposes only and should not be taken as a recommendation to buy or sell any security. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.

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