Trading FED vs. ECB benefits macro strategies

• The Fed and the ECB took center stage The Fed and the ECB took center stage The Fed and the ECB took center stage – again – in November. The October 28 FOMC statement downplayed abroad risks and specified that members would consider "at the next meeting" whether action would be appropriate. It spurred an orderly but clear market repositioning. Later on, several ECB comments built up expectations for additional monetary easing at their December meeting. Tactical positioning around these two catalysts dominated markets. It mainly benef It mainly benefitted to CTAs, itted to CTAs, itted to CTAs, Global Macro Global Macro Global Macro and Variable L/S Equity funds. and Variable L/S Equity funds. Most other strategies Most other strategies Most other strategies recorded recorded mixed returns.

• L/S Equity kept their cautious exposure, with li L/S Equity kept their cautious exposure, with limited portfolio ed portfolio changes. The strategy made slow and steady gains over the month. Equities were not the markets’ epicenter. Trading volumes remained subdued ahead of the Fed and ECB meeting. Managers’ positioning remained cautious - even among the long US bias funds - and portfolios were little changed. Amid a lack of directionality, the alpha was mainly produced on short books. Asian and UK focused managers were the most successful at this. European managers underperformed, not helped by a disappointing earnings season. Market neutral funds continued to suffer from momentum and sector rotations. After weeks of poor alpha conditions – with high correlation and poor dispersion - the backdrop is now recovering in most G3 markets.

• Merger Arbitrage outperformed their Special Situation peers. A greater opportunity set in the M&A space and few closing operations helped offset losses on Perrigo - a deal which accounted for an average 6% of the Merger fund net exposure. Indeed, the Mylan hostile deal on the Irish drug maker Perrigo failed. Mylan couldn’t gather the required shareholder majority with a view to participate in the wave of consolidation in the generic drug industry. In contrast with recent months, deal spreads were generally wider, driven both by more aggressive M&A operations, and higher risks. Risks include antitrust decisions due in 2016 for several mega deals and the threat from tax inversion regulation. This space is offering greater room for alpha generation.

The returns of Special Situation funds were rather macro than company-specific driven. In particular, the healthcare sector, a key culprit for the recent underperformance, staged a mild rebound, with limited stock discrimination. Meanwhile the recovery in the pricing of corporate operations continued, though at a slower pace than headline markets. The cost of the portfolio hedges, implemented since October, was a substantial explanatory factor for this month’s negative returns.

• L/S Credit continued to underperform Fixed Income continued to underperform Fixed Income continued to underperform Fixed Income Arbitrage Arbitrage funds. US credit markets were under increased pressure in November. The underperformance of HY relative to IG, loans or equities expressed concerns about the coming Fed normalization and a new slide in oil prices. With default rate and liquidity stress on the rise, credit concerns stepped up. In that context, L/S credit funds limited the damage, thanks to a cautious positioning, especially in the sectors which suffered the most – Energy and Telecom. Those focusing on European markets outperformed, in a market supported by improving macro data and by the ECB initiatives to boost credit in Eurozone. Fixed Income arbitrage funds continued to exploit dislocations in the relative pricing of cross credit markets. The alpha potential in this space has become attractive.

• CTAs more than more than more than recouped their post-FOMClossesin bonds in bonds in bonds. CTAs started in the red, hurt by the rate reversal triggered by the end-of-October FOMC. They fully recovered these initial losses over the month. As the odds for a December Fed start and ECB’s additional stimulus built up, long USD crosses and Euro bonds generated strong P&L. While CTA models cut most of their US long bond positions, they continued to strengthen their equity holdings. By month-end they remained long USD and equities, short European bonds and very short commodities – including in agricultural.

• Global Macro funds made the Global Macro funds made the Global Macro funds made themonth on their long held bullish month on their long held bullish dollar trade (especially against GBP, Euro, JPY). The bulk of their November return was generated thanks to their USD crosses in the aftermath of the FOMC. In contrast, their long equities were not a substantial contributor. They started November with a moderate rate exposure, with increasingly active tactical positioning around monetary announcements. By mid-month, they reweighted more firmly their long US bonds and their short Euro bonds – implicitly giving credit to a bold ECB action. By month-end there were net neutral on US equity and long both European and Japanese stocks. They were also short base metals but neutral energy, with a long US vs. short European bond exposures. They continued to reinforce their long USD play.

“The cycle remains tame, but it is aging and asynchronous. Markets remain subject to these conflicting forces. Those forces supporting volatility and dispersion will prevail in our view, making hedge funds attractive.” says Jean-Baptiste Berthon, senior cross asset strategist at Lyxor AM.