Positive performance defies volatile markets

The first quarter of 2021 was positive for most asset classes. However, financial markets were far from calm.

Indeed, there has been no shortage of disruptive events, from the rise in long-dated US Treasury yields that led to a sell-off in bonds, to peculiar events, such as the dismissal of the head of the Turkish central bank the day after it raised interest rates.

Hedge funds enjoyed a strong quarter: the HFRI Fund Weighted Composite Index, the main hedge fund benchmark, gained 6.0%, thanks to positive performances by all strategies. On average, event-driven strategies performed best, gaining 8.2%, followed by (long/short) equity hedge strategies, which were up by 7.1% and both benefited from the rise in developed equity markets in February and March.

Market review

In terms of regions, in the first quarter of 2021 Japanese and European equity markets rose strongly, while emerging markets underperformed. In China, fears of fiscal tightening measures, tougher anti-trust regulations and geopolitical tensions led to a sell-off that lasted from mid-February until the end of the quarter.

Most commodities rallied in the first quarter, driven by government stimulus programmes as well as rising confidence in a post-COVID-19 recovery. The expectation of higher inflation also played its part. However, these very factors that boosted commodities dented the performance of fixed-income markets.

Another notable development in the first quarter was the rise of active retail investors in single stocks. Boosted by free online brokerage platforms, higher spending power thanks to government handouts and investment clubs on social networks, retail investors emerged as a powerful market-moving force that raised some previously neglected stocks to unprecedented levels with the purpose of hurting those hedge funds that were speculating on their decline. Those hedge funds that were not betting on a fall of these stocks benefited from the resulting increase in volatility that created better entry and exit prices, ultimately increasing their opportunities for outperforming the market.

Overview of the most common hedge fund strategies

Long/short equity

The positive performance of long/short equity strategies in the first quarter of the year is a testament to the developments described above. In a stark reversal of fortune, the technology and healthcare stocks that did so well in 2020 lagged behind in the first quarter of 2021. For this reason, Chinese equities generally performed poorly, since they have a strong bias towards technology and growth. Instead, strategies focused on the energy and materials sectors did particularly well in Q1.

Global macro

Macro strategies rose by 3.4% over the quarter, driven by gains in both February and March. This strategy benefited from the rise in US Treasury yields, particularly from the widening spread between short- and long-dated yields. In contrast, a few unusual events, such as the near-16% slump in nickel prices in March, the decline in several green energy assets and the devaluation of the Turkish lira by 11%, detracted from the overall positive performance of many global macro strategies.

Credit & event-driven

These strategies performed well thanks to a recovery in the fortunes of many companies that had been hurt by COVID-19 in previous quarters. This should set the scene for the beginning of a strong period for this strategy, as fund managers take profits from assets acquired cheaply over the course of the previous year. Q1 was one of the most active first quarters for mergers and acquisitions (M&A) on record, which was a boon for event-driven strategies. They were boosted further by high activity in new stock market listings (IPOs), even though the strategy’s fortunes turned slightly negative in March. Merger arbitrage strategies still performed well as a group over the quarter thanks to a healthy deal flow.

Relative value

Relative-value strategies were strongly positive in Q1, particularly the less liquid strategies, with convertible arbitrage being the top performer thanks to a gain of 4.6% over the quarter. However, in March convertible bond issuance ended up exceeding investor demand, causing a slight fall in prices. Structured credit generally performed well, as did volatility trading strategies.

Systematic strategies

The first quarter was positive for systematic strategies. Strong gains in February – and especially March – were able to compensate for losses incurred in January due to high volatility. The quarter was equally positive for strategies seeking to exploit alternative risk premia. These benefited from the uptick of “value” stocks as opposed to the “growth” stocks that led the market last year.

Outlook

Long/short equity strategies are expected to keep being driven by the favourable context for equity markets. Most managers in this strategy believe that strong corporate earnings will override negative factors, such as rising interest rates, tax rises and tensions between the US and China. Given this, moderately long-biased strategies should do best.

Macro strategies tend to benefit from economic stimulus measures, especially in terms of fiscal policy. Steepening yield curves that prompt yield curve controls by central banks would result in currency movements, favouring discretionary macro strategies while other strategies struggle.

Credit & event-driven strategies are part of our high-conviction ideas. Distressed strategies in particular may benefit from ongoing restructurings and corporate recoveries, keeping in mind that private credit and distressed debt financing remain the only options for many smaller companies to restructure their debt. Merger arbitrage strategies should benefit from high M&A activity for the rest of the year.

Relative-value strategies should benefit from a divergence in the asset prices of individual companies, sectors and regions as a result of the uneven way the health crisis has affected the economy, as well as the nascent recovery. Wider spreads, paired with higher volatility across asset classes should create more opportunities to trade.

Systematic strategies are set to profit from greater price volatility, dispersion and volume, combined with lower correlations among the prices of individual securities.

Fredrik Langenskiöld
Senior Investment Specialist
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