Hedge funds gain for February

All hedge fund strategies gained for February with especially strong performance for systematic CTA's and fundamental growth strategies as measured by the HFR indices. Managed futures showed gains because both equities and fixed income markets trended higher for the month. The fundamental growth strategy seemed to be positioned to take advantage of the global reflation trade. Other winners included market directional and distressed restructuring strategies. 

With good performance in both January and February, most hedge fund strategies are positive for the year. The only exception is merger arbitrage where new opportunities have been limited during these first two months of the year. Performance is within an expected range given historical market betas. However, it is unlikely that these positive gains for all strategies will continue given the wide differences in styles and market exposures.  

Long-term worry with trade

The global macro manager is always worried about a few key issues. Where will country and global growth come from? What will be the flow of liquidity and credit to markets? What will be the desire by investors for risk-taking?  The answers to these questions will describe the drivers of future asset returns. 

As trade flows have gotten bigger over the last two decades, it has become a more important growth component to watch. While capital flows are still more important to financial prices in the short-run, trade is a key link that will allow for spill-over and multiplier growth effects.

Our review of the WTO trade volume suggests that trade will still be a drag on global growth. The old trade growth rate looked like it was going to return after the Great Financial Crisis, but those rates have not been realized. The slowdown in trade volume has been in the works for years. This lower trend is not a recent phenomenon. The talk of new trade deals and Trump bilateralism is a symptom not a cause of the slowdown. A slower growth rate makes countries fight for trade volume market share. More protectionism is a response to falling trade trends not a solution. Trade slowdown and protectionism coupled with a decline in capital flows and greater controls will continue to place a drag on growth opportunities.

Managed futures show strong performance with financial trends

Managed futures strategies generally showed performance gains in February based on strong equity market return trends and the the positive gains in fixed income markets. The dollar also started to again trend up while commodities markets were more mixed. It is notable that there was a strong gap between traditional trend-followers and short-term traders whose index was down almost 2% for the month. 

While we don't want to make generalizations, the largest CTA's are heavily weighted to financial markets so if both bonds and stocks do well it is likely that CTA's will do well. This is especially the case if the bonds move to the upside. Generally, CTA's will do better when there is a bias to lower bond yields. Bond sell-offs are usually quick and choppy which hurts performance. Nevertheless, the end of the month was rocky for bond markets. They started to move lower on more talk of earlier Fed rate rises.

Commodities were not a strong contributor to performance because of some choppy moves in grains and range-bound behavior in oil markets. There were some exceptions like natural gas but the high volatility in this market usually leads to smaller allocations.

The dollar has returned to its up trend. With US shorter-term rates trending higher, the rate differential is very dollar favorable. It is hard to fight carry economics when monetary expectations are in favor of the trend.

While CTA's did better for February and are positive on the year, the 12-month rolling average favor equities. For many investors, under-weighting of equities in 2016 has led to catch-up behavior with less interest for diversification.

Finance and Political Worlds Continue to Diverge

If I invested based on political rhetoric and news, I would be moving to a safe asset and expect stocks to decline. The uncertainty concerning policy and the animus between political parties and countries would suggest an environment that would not be suitable for the long-term optimism that is needed to see equities march higher. If I read just the financial papers and economic data, I would paint a more optimistic picture with consumer and business surveys both showing a positive environment. If I were a focused policy wonk, I would have a mixed view on market prices with the potential for stimulative policies but still a policy environment where details and specifics are scarce.  It is hard to see these differences continuing. As politics, economics, and policy come into focus, there will be a strong reaction in price. Unfortunately, predicting when this alignment will occur is very difficult.

We are surprised with the positive performance across the broad set of asset classes and styles followed monthly. Risky EM stocks and bonds both performed well in spite of the clearer rate rising environment signaled by the Fed. Large cap equities outperformed riskier small cap, value and growth. Long bonds outperformed credit sensitive fixed income. The only asset class without strong movement has been the commodity space. Commodities have seen lower correlation intra-class as these diverse markets have moved away from the negative commodity cycle.