Low Beta strategies lead the pack as equities drop

Equity market volatility stayed elevated in March, as tech stocks were under pressure over user data privacy and the U.S. administration announced trade barriers targeting China. The MSCI World was down 2.5%, extending February’s 4.3% loss. U.S. and Japanese indices underperformed, while the European market outperformed. At the sector level, defensive sectors such as utilities, consumer staples and energy outperformed, both in the U.S., the EMU and China. Meanwhile, IT and financials suffered, along with trade sensitive sectors such as materials and industrials.

Unstable market conditions were supportive for hedge funds, in relative terms. Liquid hedge fund benchmarks were down -1% in March, with Distressed and Special Situations strategies underperforming. On a positive note, low beta strategies did well. CTAs managed to limit losses, in particular during the rise in risk aversion over the last two weeks. Short USD and long commodity positions were rewarding for them as the U.S. dollar depreciated and commodities jumped in the context of looming trade wars. Long equity positions detracted however. Meanwhile, Merger Arbitrage, Fixed Income Arbitrage and L/S Equity Market Neutral also outperformed in March and over the last two weeks. These are typical low beta strategies that are increasingly attractive as the tradeoff between strong growth and monetary tightening is set to translate into a structurally higher volatility regime. Merger Arbitrage is especially attractive in the context of strong M&A volumes thus far in 2018, which we discuss on page 2 of this report.

In the near term, we believe risk assets could experience a short term rebound. The great health of the US economy and our expectation that Trump’s fierce rhetoric over protectionism could have reached a peak, at least temporarily, is supportive. Yet, longer term, our appetite for risk is diminishing. In terms of hedge fund recommendations, that will gradually translate into a reweighting of low beta strategies (we currently maintain an Overweight stance on Merger Arbitrage and Fixed Income Arbitrage, but we are Underweight CTAs and at benchmark on Market Neutral L/S) and a downgrade of high beta strategies such as Special Situations, on which we are currently Overweight.