Editor’s Letter – March 2013

Originally published in the March 2013 issue

If financial markets are normalising, this is beneficial as most strategies ended the first quarter positively. The collapse of correlations between and within regions, asset classes, equities and credits has helped many funds that rely on fundamental security selection to generate their alpha and returns.  Huge geographic divergences have been seen with emerging market equities ending the quarter down while US equities just about advanced by double digits. Looking at sectors, US banks were up while European banks were down. Managers on the right side of these relative value trades have generated strong returns without any real beta risk, especially in long short equity.

The stand out trends were perhaps the twin phenomena of surging Japanese equities combined with a declining Yen. These strong trends have likely helped many trend following CTAs to recover last year’s losses, and some of the quarters’ top performers are either dedicated Japanese hedge funds, or those with a global remit that have moved assets into Japan.

The biggest leveraged buyout deals since 2007, in the form of Warren Buffet’s bid for Heinz and various predators circling around Dell, have helped event driven funds. Although European corporate activity has been more subdued that many had hoped, the US looks like fertile ground for deals. It is very much a stock-pickers market as some deal breaks have inflicted painful losses on some funds in the space, hampering returns for merger arbitrage.

More dispersion within assetclasses is also apparent in areas such as emerging markets currencies. Units such as the South African Rand have depreciated, while China’s Renminbi continues its upward path – so picking the right currencies rather than blindly following the carry trade has been the more lucrative approach recently. Both quant macro and discretionary macro traders have been able to profit from these moves.

Many commodities may also be decoupling from other asset classes. Base metals, gold and silver all ended the first quarter lower, while risk appetite in general was buoyant. This is another sign of greater differentiation that could reward bottom up, market specific research rather than simply deciding if markets are in risk on or risk off mode.

Some other aspects of received wisdom are also being re-examined. Reports of the death of investment bank proprietary trading and involvement in hedge funds may be exaggerated, after Goldman Sachs announced plans for a fund lending to smaller companies. Politicians and central banks alike are anxious to rejuvenate credit creation for cash starved smaller firms, and this is the type of market gap that hedge funds are nimble enough to step into. We might tentatively venture that the process of normalisation for financial markets has started – but has some way to go, and hedge funds can play a vital role in furthering this process.