In a context were both equity and bond markets rallied in Q1, hedge funds delivered returns close to +2.5% according to the Lyxor Global UCITS peer group. High beta strategies such as Special Situations, EM-Global Macro and directional L/S Equity outperformed (+3.5 to +4%). Meanwhile, relative to others, low beta strategies such as L/S Equity Market Neutral and Merger Arbitrage underperformed (+0.5% to +1%). L/S Credit and CTAs delivered returns in a range of +2% to +2.7%. CTAs delivered strong returns both last week and in March (+2.9%), which compensated for the losses in January when their short equity positioning detracted from performance.
CTAs have recently benefitted from the rally in both bond and equity prices. Momentum signals are strong in those asset classes (see charts below) as the Federal Reserve (“the Fed”) continues to surprise market participants with a dovish stance. At the latest FOMC meeting on March 20th, it announced the end of the balance sheet runoff as soon as end-September 2019, earlier than previously expected. Despite CTAs currently experiencing green shots of recovery, we maintain a Neutral stance on the strategy for the medium term. We continue to have limited visibility over a 6 to 12 month timeframe due to issues such as Brexit or trade wars, which have the potential to cause abrupt trend reversals.
In parallel, we also maintain an Overweight stance on Merger Arbitrage despite the recent underperformance. Global M&A volumes are down year-to-date but stay buoyant in the U.S. This has led several Merger Arbitrage strategies to concentrate their exposures in the U.S. The share of mega deals (above USD 5bn) stays elevated and deal spreads widened in March from very tight levels in February. In our view, there is no reason to reconsider the stance on Merger Arbitrage. The strategy is a powerful source of portfolio diversification due to its low correlation to equities and would provide protection if risk appetite fades.
Finally, perspectives on carry strategies such as EM-focused Global Macro and L/S Credit improved in our view. We maintain an Overweight stance on those strategies, assuming a low bond yield environment will prevail over the medium term.