Markets in July were dominated by two major macro issues: US debt ceiling negotiations and Eurozone sovereign debt. Concern over these and other issues (soft economic data, monetary tightening fears in China) limited risk appetite and led to a flight to safety, in which “safe haven” assets benefited at the expense of equities
Markets in July were dominated by two major macro issues: US debt ceiling negotiations and Eurozone sovereign debt. Concern over these and other issues (soft economic data, monetary tightening fears in China) limited risk appetite and led to a ‘flight to safety’, in which “safe haven” assets benefited at the expense of equities.
In currencies, the euro fell 2.9% on lingering Eurozone contagion worries. The US dollar fell 1.3% as disappointing economic data, debt ceiling uncertainty and the potential for an S&P credit downgrade, called its safe-haven status into question. Risk-wary investors responded by fleeing to the safety of alternative ‘safe haven’ currencies such as the Swiss franc and Japanese yen.
Commodities saw a strong month. Gold and silver were boosted by the ‘flight to safety’, while palladium prices benefited from South African mining strikes. Copper prices posted solid gains due to a strike at Chile’s Escondida mine (the world’s largest copper mine). Elsewhere, wheat rose 15% after adverse weather conditions in the US damaged crops. But cotton plummeted over 35% on reports that Pakistan’s farmers had planted a bumper crop in response to last years’ high prices.
Looking ahead, we believe markets are currently focused on macro events, reducing dispersion between ‘good’ and ‘bad’ stocks. When the macro picture becomes more certain, ‘pent up alpha’ should be released as stock dispersion improves.
Hedge funds delivered mixed returns as debt concerns, combined with low summer volumes, created a highly volatile environment. However, managed futures rebounded sharply, profiting from long fixed income positions, as well as from having maintained relatively high levels of risk. Global macro managers posted gains in fixed income, while trading in commodities also proved favourable. However, profits were comparatively subdued as managers remained cautiously positioned, especially relative to managed futures managers. Outside of managed futures and global macro, returns were relatively flat.
Managed futures and global macro
Managed futures managers shone amid the turmoil, bouncing back from two consecutive down months to bring YTD returns to around flat. Strong trends were key, as was managers’ ability to maintain risk levels when managers in most other styles were taking risk off the table.
Gains were largely attributable to strong trends in fixed income. Other safe haven assets also drove positive returns. On the negative side, equity trading resulted in mixed performances as equities suffered from a high level of intra-month volatility, which the month end performance returns fail to represent. Looking forward, the positioning of managed futures managers has continued to play out well in the extreme market moves we have seen in early August.
Global macro managers also bounced back in July. However, many managers were running at reduced risk levels as they waited for a clearer picture on major macro issues, leading to more muted returns. The best performers over the month tended to be those with more bearish outlooks. Emerging market-focused global macro managers posted small positive moves over the month, with commodities-focused managers also doing well.
Relative value funds were generally flat in July. The flat return masks dispersion amongst sub-styles and came amidst a backdrop of growing market uncertainty even before the turbulence of early August.
Convertible bond managers were among the worst performers as convertibles suffered from the reduction in risk appetite and general equity market decline. Credit arbitrageurs enjoyed a more beneficial market environment following the difficulties in June, although delays on the US debt ceiling resolution ultimately pared returns. Defensives and higher quality credit names outperformed, while high beta sectors underperformed.
Equities posted another month of declines in July as macro concerns over sovereign debt dominated proceedings. However, monthly returns hide the true story of what was a highly volatile month for equities as investors faced multiple direction swings. Given the market environment, it was unsurprising to see defensively positioned managers and those with lower net exposures performing the best.
In the US, the S&P 500 declined 2.1%, driven principally by debt concerns. European markets and hedge funds fared worse as a poor earnings season was compounded by extended debt issues in Italy, Spain and Greece. Managers who cut risk over the month or had a short bias protected capital most effectively. In Asia, initial gains were driven by local factors, but markets receded as debt concerns undermined appetite globally.
The event driven universe finished July relatively unchanged. In special situations, the HFRX Special Situations Index fell 0.6%, reducing year-to-date performance to 1.6%. However, broader equity special situations managers outperformed pure merger arbitrage managers with the HFRX Merger Arbitrage Index falling 0.9% over July. Deal spreads widened on increased risk aversion, particularly towards the end of the month.
Deal activity remained high, with the highest levels seen in private equity-related deals, although the level of year-on-year increases has slowed in recent months. Within the event driven style, distressed funds fared best, although they were still hit by subdued risk sentiment and declining equity markets. The HFRI Distressed Index ended down less than 0.1%.