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Corporate bonds and Managed Futures – A Winning Diversification Combination
Managed futures may not generate crisis alpha if there is no crisis, a sustained decline in equities. In addition, managed futures may not provide as strong a cushion diversification effect during normal times since the correlation between equities and managed futures is slightly positive, and there is no managed futures yield. So how can an […]
Financial Conditions – No Signal of Tightening. Trend Says Stay the Course with Risky Assets
The Fed has become more focused on financial market conditions since the Financial Crisis. There is less interest in the classic goal of managing full employment since by many measures we may beyond the natural rate of full employment, and there is admitted confusion on how to control inflation.
Equity Asset Class Value Rotation – Look Outside the US for Upside and Protection
The talk has focused on the overvaluation and “bubble” with US stocks, but there are other relative opportunities in risky equity assets. A comparison of CAPE across the world shows that the UK, euro area, and Japan valuations are closely tied together, significantly below highs from 2008, and all relatively cheap versus US.
“Risk of a Rapid Repricing in Global Markets” – (ECB) With this Narrative, Investors Need Strategies that Generate Portfolio Gamma
“Risk of a rapid repricing in global markets”; this ECB quote was a key talking point in the press release from the ECB Financial Stability Report issued last week. Note that “rapid repricing” is a polite way of saying asset price declines.
Hedge Fund Performance Mixed, but some Bright Spots with Fundamental Growth and Systematic Macro
Hedge funds returns were mixed for November, but the fundamental growth and systematic macro strategies generated strong returns of over 1 percent. The fundamental growth strategy is the HFR leader for the year with a return profile at over 17%. The macro systematic strategy again generated a strong positive return. The HFR macro systematic index return was significantly higher than other systematic indices for November which suggest a high dispersion across managers in this category. The macro/ CTA which includes discretionary managers was actually down for the month. The absolute return, special situations, and emerging markets strategies were the biggest down strategies for the month, but all showed declines of less than one percent.
Managed Futures Slightly Positive in a Choppy Environment – Performance Driven by Asset Class Weights
Managed futures managers were, on average, positive for the month with returns beating commodities and the fixed income Barclay Aggregate index. Managed futures did not beat the strong equity performance but that should not be a surprise given that equity exposure will only be a small portion of the total risk exposure for managers. Most managers will cap the equity exposure within the program, so even if equities are trending higher, performance will lag a long-only index.
Sector Return Performance for Equities Strong across the Board – Hold Overweight in Equities
Equity style sectors were strong across the board with only emerging markets posting a negative November return; however, emerging markets have been the best performing sector year to date. The value index showed a strong gain although it still lags the growth index year-to-date. Trend indicators are all positive except for emerging markets and the short-term trend in the small cap index. Price indicators suggest that there is no reason to cut equity exposures.
Trends Signals Still Mixed in Many Asset Classes – Long US Equity Indices Still Strongest Signal
Trend behavior last month was mixed for many CTA managers. The allocation weights had a significant impact on November performance. We believe there may again be significant dispersion in performance because trend dispersion is high. For example, US stock indices show strong up trend signals while non-US stock indices are showing clear short signals. The opposite is the case for bonds where US bond signals are for short positions while non-US bonds signals point to long positions.
Stocks Continue Their Strong Performance – Hard to Fight Equity Trends; The Opportunity Cost of not Following Trends is High
A combination of good economic growth news and a fiscal policy tailwind again drove US equity markets. The discounting of a US fiscal accelerant shows up in the positive US-global return differential for the November.
Active Cash Management for Managed Futures – A Simple Addition to a Fund’s Return Profile
Managed futures have unique features given that margin is only a small potion of the total investment. This allows for active collateral management in ways that are more impactful from other hedge funds. For most hedge funds that use a prime broker and make long/short equity investments, the focus of collateral management is with reducing the cost of borrowing. For futures, the leverage is not through borrowing but through the ability to increase notional funding based on the level of margin to equity. A good portion of funds given to any CTA is not managed efficiently but rather just held in cash.
Expected Yields and Returns for Bonds are Still Low – Go Get More Alternatives
The asset allocation decision concerning the addition of alternative investments, especially for diversification strategies, is actually quite straightforward. One, find strategies that have low and stable correlations with stocks and bonds. Two, find strategies that have a minimum acceptable return that will beat a traditional diversifier.
Normalcy for Stock Bond Correlation Says You Need Other Forms of Diversification
The bond diversification story is based on the strong negative correlation between stocks and bonds that has existed for over a decade, yet it is not a given that stocks and bond returns will move in opposite directions. A quick look at a very long history from a Wellington Management chart tells us that the negative correlation is the exception not the rule.
The Tale of the Tail – Focus on the Where, Why, and What is Wrong; Use Strategy Diversification as a Solution
Along with any discussion of asset bubbles, there is a complementary discussion concerning tail risk. If there is a bubble, there is likely to be a tail in the future. Bubbles and tails are tied together, yet tail events can occur even if there is no bubble.