While global equities lost ground in the third quarter of 2014, liquid alternatives consolidated their gains from the first half of the year. Discretionary macro and trend-following strategies were among the top performers, according to a briefing paper published by Deutsche Asset & Wealth Management (Deutsche), as diverging central bank policies provided opportunities for alternative strategists in the fixed-income and currency markets.
In the paper, Deutsche offers a brief review of each of the following alternative strategies and current recommendations for portfolio positioning of each strategy:
- Long/short equity
- Market neutral equity
- Discretionary macro
- Credit strategies
What follows is a summary of Deutsche’s analysis of each alternative strategy.
The choppiness of the broad stock market in Q3 – “risk-off” in July; “risk-on” in August; and mixed in September – put the focus on stock picking, the long/short equity specialty, rather than trend following or asset allocation. U.S. stock pickers in particular found “the operating environment more supportive than in European markets,” according to Deutsche.
Market-neutral equity strategies underperformed in the second quarter but bounced back in the third, with the HFRX Equity Market Neutral Index posting its second-largest gain in more than three years in August. According to Deutsche, “gains occurred across factor-based models as well as fundamental and trading strategies.”
As the broad bull market in stocks led to a flight of assets from market-neutral strategies, it became easier for market-neutral strategists, less constrained by size, to find better opportunities. What’s more, the flow of funds out of market-neutral has led to the survival of the fittest managers, improving their prospects for Q4 and 2015.
Deutsche says the third quarter of 2014 was a “defining period” for discretionary macro strategies, with the class advancing in each of the quarter’s three calendar months. Positive performance was delivered by substantial bets on the dollar vs. the euro, as well as directional positioning in long bonds, and relative-value equity trades. Returns over the quarter were broadly based across asset classes.
Commodity Trading Advisors
CTAs posted gains in the third quarter, despite the continued decline in most commodities markets. The HFRX Systematic Diversified CTA Index added 1.55% in August, thanks to currency trends, rising U.S. bond prices, and further advances in the U.S. stock market.
Credit-strategy managers that were net-short high-yield bonds or had balanced books in the third quarter were rewarded, according to Deutsche. The bearish turn for high yield was caused by the “valuations in this sector moving ahead of fundamentals.” Relative-value credit strategies benefitted from corporations’ continued and elevated levels of refinancing.
Kiboshed tax-inversion mergers weighted on event-driven strategies in the third quarter, as Congress passed laws discouraging the tax-reduction strategy that had been a boon to M&A activity. Two unrelated deals also fell through in early August: Sprint’s proposed takeover of T-Mobile, and 21st Century Fox’s proposed acquisition of Time Warner.
Investors in distressed assets had “nowhere to go” in the third quarter, according to Deutsche. The HFRX Distressed Index gave back gains over the period “as spreads backed up across many segments of the market.”
Deutsche concludes its briefing with a list of nine expectations, as well as allocations to strategies ranging from “overweight” to “underweight” for each alternative class.
- Long/short equity, market-neutral equity, and event-driven are given “overweight” ratings;
- Discretionary macro and credit strategies are given “overweight/neutral” ratings;
- CTAs are given a “neutral/underweight” rating; and
- Distressed strategies are assigned a pure “underweight” rating.
Overall, Deutsche’s 12-month forecast for alternative strategies is “neutral/positive” with a projected 9.1% return.
For more information, download a pdf copy of the report.