Higher bond yields and political uncertainty took a toll on risk assets early October. In the U.S., strong macro data releases raised fears of overheating, lifting Treasury yields since late August. Concurrently, the standoff between Italy and the EU on fiscal expansion, and the rocky trade negotiations between the U.S. and China, have amplified market concerns.
Hedge funds were not immune to recent market developments. They were down during the first half of October due to the underperformance of CTA, L/S Equity, and Special Situations strategies. Meanwhile, Merger Arbitrage, Fixed Income Arbitrage, Global Macro and L/S Equity Market Neutral strategies were resilient.
In our view, worries about overheating are overdone. The U.S. economy is set to decelerate as the fiscal boost will soon fade. We don’t think the Fed will accelerate tightening. In the midterm, we expect nonetheless the volatility regime to remain high compared to recent years.
Our views on alternative strategies were comforted in Merger Arbitrage and Relative Value Arbitrage (Overweight), but challenged on CTAs. Trend followers took a hit recently due to long equity positioning as well as fixed income and commodity allocations. The drawdown was comparable to earlier trend reversal episodes this year. The selloff has led to portfolio deleveraging, suggesting the strategy might not benefit from a market rebound if it takes place. We downgrade the strategy to neutral.
