Fixed Income Arbitrage Outperforms In A Rising Rate Environment
Hedge Fund Briefs - February 2017
Bond yields continued to edge higher over the recent weeks, on the back of stronger economic data and higher inflationary pressures. The rise in bond yields was more pronounced in Europe than in the U.S. across the curve, which contributed to the appreciation of the Euro vs. USD. This environment has proven supportive for risk assets in the U.S. and emerging markets.
With regards to Hedge funds, their performance is flat year to date. Across strategies, Global Macro and CTAs are down, while Fixed Income Arbitrage and Event Driven outperform.
CTA and Macro managers suffered on their FX bucket and in particular on their long USD positions versus the Euro. Some Macro managers maintaining a preference for European equities were also penalized to the extent that the European equity market underperformed the US market. Some CTAs were penalized by long energy contracts within the commodity space.
On the positive side, Fixed Income Arbitrage and L/S Credit funds outperformed. They have been supported by both alpha and beta components. The rise in bond yields has created arbitrage opportunities for Fixed Income arbitrageurs such as the deviation between cash and futures bond prices (the so-called basis). Meanwhile, beta conditions were supportive for L/S Credit funds as high yield spreads tightened lately on both sides of the Atlantic. Going forward, while we are cautious on directional L/S Credit funds, Fixed Income Arbitrage appears to us to be attractive to protect portfolios as we believe 10-year Treasury yields could reach 3% by the end of 2017.
Finally, Event-Driven is also a strategy on which we have constructive views for 2017. Its recent outperformance was related to some pharma deals such as the USD 30bn planned merger between Johnson & Johnson and Actelion, a Swiss biotechnology firm which is the top long exposure of merger funds in our sample. The corporate tax reform envisioned by the new U.S. administration has been considered to be an opportunity for both the technology and the pharma sectors. They would benefit from tax breaks on cash repatriation. This could potentially extend the wave of M&A activity in these sectors. Event Driven managers appear to be at the forefront to benefit from it.