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A dovish Fed is set to support CTA and macro managers

Monday, September 21, 2015
Opalesque Industry Update - Markets were on standby mode ahead of the Fed’s meeting last week. Hedge funds were flat and there was little dispersion in returns across the managers. Event-Driven outperformed as equity volatility edged lower. Meanwhile, Fixed Income strategies underperformed as sovereign bond yields moved higher.

Since the FOMC meeting on September 17th, the Fed’s indecisive attitude has been met with mixed responses from the markets. A lack of guidance has not been welcomed by risk assets, bonds have rallied and the USD has eased against major currencies. It is likely that this will fuel Global Macro and CTA managers in particular.

Systematic funds are adequately positioned, being neutral equities and long fixed income. These funds also cut their long USD positions (especially against the EUR) during the summer. There are nonetheless discrepancies between the positioning of short term and long term CTAs. The former have less directionality in FX and commodity markets and appear to be better suited to capture any benefits from the new market regime. In fact, long term CTAs are still long USD and short commodities. The Fed’s stance is likely to put downward pressure on the USD and some upward pressure on commodities.

Meanwhile, discretionary Macro managers are also long fixed income and are set to benefit from the ease in bond yields following the downward revision of both the economic projections and the “Dot Plot”.

Finally, the Fed’s lack of guidance over future interest rate moves could result in higher risk aversion despite this dovish stance. In the L/S Equity space, we maintain our strong preference for market neutral and variable bias strategies. Some managers in that space have delivered double-digit returns year to date and we expect this trend to continue.

The Lyxor Hedge Fund Index ended the week flat, with little dispersion in returns between strategies.

Event Driven outperformed, with merger arbitragers leading the pack (+0.4%). Investments in consumercyclical and technology sectors were particularly rewarding while energy related names detracted from the overall performance.

L/S equity funds were resilient and fuelled by variable bias funds (+0.5%). Three variable bias funds were among the top three performers of the platform with our Japanese-focused variable bias fund up 1.4% last week.

CTAs and Global Macro managers suffered from the upward pressure on yields as a result of having long exposures to fixed income.

The market was not suprised by the Fed's decision to hold interest rates at historic lows, maintaining its 0 to 0.25% target range. This decision suggests that Fed policymakers are concerned over an increasingly brittle global environment which may damage the US economy. The US recovery may face headwinds from a stronger US dollar and a weaker China. Meanwhile, falling energy prices may push inflation downwards. The median estimates for the benchmark Fed Fund rate to end 2015 fell by 25 bps compared to the last FOMC meeting in June.

The dovish tone of the Fed triggered a downward pressure on Treasury yields. CTAs and to a lesser extent Global Macro managers benefited from this trend as they both have long exposure to fixed income.

Going into the FOMC meeting, near term Fed fund futures did not display any immediate hikes in price, however 2- year Treasury yields did edge higher.

Over the last three months, a bear flattening of the yield curve has taken place, with yields on 2-year notes reaching 0.8% the day before the FOMC meeting. In contrast, moves in 10y Treasury yields were moderate and were driven by concerns over the lowflation outlook.

However, the dovish stance of the Fed has changed this outlook. The long-end of the curve is now rallying in the US and in Europe especially. This trend is supportive for Macro managers who have long duration positions and aggressive positions on Europe.

Over the last week, CTAs posted slightly negative performances with the Fixed Income portfolio accounting for most of these losses. Widely long exposed systems were penalised by the upward trend of rates on both sides of the Atlantic, with markets witnessing an increasing correlation between European and US treasuries.

In less volatile markets, the contribution of equities to performance was limited. Short positions proved rewarding on European indices, but also brought losses on the US markets. Short-term CTAs were in the best position to gain from these market moves.

The FX bucket was also down mainly on the back of its short exposure to the Euro which appreciated against the US Dollar. Short Australian Dollar positions brought losses as well.

Lastly, short exposed systems managed to extract alpha on commodities after making the most of the downward trend of energy and precious metals prices.

Global Macro funds were down last week.

Fixed Income markets were focused on the pending Federal Reserve monetary policy decision. Consequently, funds with long duration positions were dragged down after rates went up in the US and in Europe.

The FX bucket posted mixed results. As the USD depreciated, short EUR/USD and short AUD/USD negatively impacted performance. Meanwhile, some long bets on EM currencies against the greenback proved rewarding.

Equities remained muted as managers reduced their risk allocation to the asset class. However, long Japanese indices paid off while long European stocks brought losses.

The exposure to commodities has remained limited once again; hence the performance was only slightly impacted by the drop in energy and precious metal prices.

What do you think?

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