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Merger Arbitrage outperformed while L/S Equity as well as Special Situations strategies underperformed. Relative Value Arbitrage and L/S Credit strategies remained pretty much resilient despite the widening of high yield credit spreads in the U.S. and Europe.

Market Neutral L/S Equity strategies were one area of disappointment in November. The strategy underperformed as momentum stocks suffered another hit.

"We have long highlighted the sensitivity of the strategy to the momentum equity risk factor over the long run. Our estimates suggest that such sensitivity, which was limited early September, rose markedly since then," it said.

Based on a sample of 35 L/S Equity Market Neutral UCITs funds, the median performance is -1.6% in November, the worst performance is -9.1% and the best performance is 4.1%. Only 17% of the funds in our sample were in positive territory last month.

"Digging into the roots of the momentum headwind, we find that it has been highly vulnerable to the reversal in Technology stocks. Finally, our views on the Market Neutral L/S strategy have been somewhat defensive. We maintained a neutral stance on the strategy throughout the year. Our lack of enthusiasm for the strategy reflects its perpetual vulnerability to momentum reversals," Lyxor said.

"At the same time, we haven't been recommending an outright underweight stance due to the benefits of low beta strategies in the current environment. Our stance remains unchanged, with a bias towards an upgrade at a later stage as risk appetite is likely to remain limited in 2019, in our view," it said.

Equity Market Neutral strategies took a hit in November while CTAs underperformed in early December

Hedge funds fared better in November compared to October but still ended the month in negative territory. Merger Arbitrage continued to outperform last month in a very robust M&A context in the U.S. (but not in Europe) despite the turmoil in equity, credit and commodity markets.

CTAs underperformed in early December, partly due to the U.S. Dollar reversal. FX remains one of the few asset classes where CTAs maintain directional positions. The strategy has been long the U.S. Dollar vs. Euro, the British Pound and the Japanese Yen in recent quarters.

Concurrently, CTAs have trimmed positions in equities, bonds and commodities lately.

The momentum risk factor has been highly correlated to Technology stocks

"Digging into the root cause of the momentum's headwinds, we observe that it has been highly vulnerable from the reversal in Technology stocks," it said.

The 6-month correlation of daily returns between a momentum index (market neutral and focused on U.S. stocks) and individual sectors (net of the S&P 500) is the highest for Information Technology (65%) and Consumer Discretionary (37%) sectors.

This suggests that momentum stocks have been reflecting the strength of the U.S. economy at a time of looming recession risks, which we believe are overdone at the moment.

It also points to the fact that Market Neutral L/S strategies were implicitly long cyclical stocks and short defensive stocks. This explains their poor performance in November.

Concerns on U.S. recession risks caused the momentum reversal

"While the momentum index we use has proved to be positively correlated with Information Technology and Consumer Discretionary sectors, the remaining sectors have shown a negative correlation," said Lyxor.

Particularly, Utilities, Real Estate and Consumer Staples sectors show the most negative correlation with momentum (-46%, -52% and -60%, respectively) over the past six months.

"Our views on U.S. sectors are defensive at the moment. While we believe a rebound is reasonably probable given an unlikely U.S. recession in 2019 and 2020, the timing of a rally is highly uncertain due to elevated political risks, which may continue to dampen risk appetite. We thus prefer defensive sectors and stay cautious on momentum, as long as it is sensitive to cyclical sectors," it said.