Lyxor Asset Management

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Communication Breakdown

Recent market developments illustrate the extent to which markets became addict to monetary accommodation. Last week, central bankers in the EMU, UK and Canada spook bond markets with self congratulating comments; suggesting monetary conditions might tighten in the near future. Sovereign bond yields rose suddenly and yield curves steepened, highlighting the extent to which monetary policy normalization will remain challenging in the years to come.

The implications of such market movements go far beyond fixed income. Within equities, bond proxy sectors such as utilities and consumer staples suffered. Meanwhile, financials did well as maturity transformation benefits mechanically from the steepening of the yield curve. In parallel, the dollar index fell, as a result of softer bond market movements in the U.S. than elsewhere, and energy prices rose. Going forward, we expect the rise in bond yields to continue in Q3 and expect 10-year Treasury yields to reach 2.6% by end-September.

Such developments have had different implications for hedge fund strategies. CTAs suffered from another trend reversal and underperformed last week. From a top down perspective, we maintain an underweight stance on CTAs. In our view, the trend following environment remains unbalanced and too reliant on equity markets. At the other end of the spectrum, fixed income arbitrage outperformed and Event-Driven was fairly resilient last week. For the full month of June, both strategies outperformed.

In the recent past, we have expressed on several occasions our strong conviction on Fixed Income Arbitrage. This is a strategy that performs well when bond yields and implied interest rate volatility rise. Fixed income arbitrage is thus very attractive to diversify long only fixed income portfolios. We reiterate our overweight stance on the strategy. Meanwhile, Event-Driven benefitted in June from the outperformance of sectors such as health care and financials, which rank high in their portfolios. Health care stocks were probably fuelled by optimism over Republican-led efforts to replace Obamacare. The sector also benefitted from strong M&A activity in the U.S. We also maintain an overweight stance on Event-Driven.

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