Uncertainty was the watchword when Neuberger Berman’s Asset Allocation Committee (AAC) met last month.
Appetite for rates remains low, understandably, but the Committee members’ outlook on risk markets had weakened, too, compared with recent quarters. Poised between the rising uncertainties around a potential trade war, the direction of the dollar and the de-synchronization of global growth, and its central scenario of an eventual return to the path of late-cycle expansion, the Committee embraced neutrality.
As a result, the focus was on specific, idiosyncratic opportunities—there was much talk about the short end of credit curves, for example, but also an increasingly positive view on hedge funds. The Committee had long favored the arbitrage, market-neutral and niche strategies of its “low-volatility” grouping, but now it has also upgraded its view on the more fundamentals-based and trend-following “directional” hedge funds.
Over in Alternative Investments, we are happy to back that view.
This is not just about looking for alpha because beta conviction is so low. We believe the environment is actively positive for a number of directional hedge fund strategies.
Fundamental Equity Long-Short has been benefitting for some time from declining stock correlations and higher dispersion. Even after the spike in correlations earlier this year, levels remain potentially attractive for stock pickers, and the ongoing return to volatility that drove that spike may present good entry and exit points for both longs and shorts. We believe the dispersion between winners and losers from U.S. tax reform, as well as further volatility coming from the transition in European and U.S. central bank policy, is likely to sustain this positive environment over the medium term.
Going down a level, we see particular opportunities for long-short specialists in the energy and financial sectors. A long period of underinvestment outside of U.S. shale (which is itself facing specific capacity issues) means a period of undersupply is likely just around the corner. Combined with a friendly political administration, we think this is creating value in U.S. midstream businesses. U.S. financials are also likely to benefit from the current deregulation trend. At the same time, we believe there will be further consolidation among smaller and regional banks.
Similar dynamics are working in Credit Long-Short, as rising rates push up dispersion of performance between different credits based on fundamentals. We believe there is also an attractive relative value opportunity in favor of high yield against bank loans. Furthermore, we see attractive shorts in weaker, over-leveraged businesses as maturity dates edge closer.
The laggards over recent months have been the macro and trend-following strategies.
Trend followers have been whipsawed this year, as they came into 2018 geared to long-running risk-on trades and got caught out in the sudden volatility spike in February. Ultimately, however, sustained higher volatility will likely be a positive for these strategies as risk budgeting adjusts to the new environment.
Macro hedge funds that trade off central bank activity and global economic fundamentals are also starting to gain some traction. Monetary policy divergence is a two-year-old story, of course, but thus far we have lacked a real catalyst to generate market volatility. As inflation starts to exceed the Federal Reserve’s target, however, the progression of the Fed’s thinking about how hot to let the economy run could generate opportunity, as could the transition of the tightening trend from the Fed to the European Central Bank.
Similarly, until the slowdown in Europe this year, globally synchronized growth had lent support to the popular long-equity, short-rates position. While the AAC anticipates a return to the more synchronized dynamic, what we have experienced in 2018 is likely to make investors focus a little more on what is, in reality, a very diverse picture around growth, fiscal and monetary policy, and the effects of politics, elections and the influence of commodity prices across different economies. The greater the disparity we see in the outlooks for different countries, the greater the influence will be on relative asset pricing, and ultimately the higher the quality of the opportunity set for macro funds. It is also worth noting that higher short-term rates generate a better return on the cash collateral that macro funds hold against the futures they use to implement their positions.
In short, we on the Alternative Investment team think there is good reason for the AAC’s positive outlook for both types of hedge fund strategies. Moreover, we feel confident that the improved opportunity set is likely to persist even after the Committee is again ready for more conviction in its market-beta views.
In Case You Missed It
- China Consumer Price Index: +1.9 in June year-over-year
- China Producer Price Index: +4.7 in June year-over-year
- U.S. Producer Price Index: +0.3% in June month-over-month and 3.4% year-over-year
- U.S. Consumer Price Index: +0.1% in June month-over-month and +2.9% year-over-year (core CPI increased 0.2% month-over-month and 2.3% year-over-year)
What to Watch For
- Monday, 7/16:
- U.S. Retail Sales
- Tuesday, 7/17:
- NAHB Housing Market Index
- Wednesday, 7/18:
- U.S. Housing Starts and Building Permits
- Euro Zone Consumer Price Index
- Thursday, 7/19:
- Japan Consumer Price Index
Statistics on the Current State of the Market – as of July 13, 2018
|S&P 500 Index||1.5%||3.1%||5.9%|
|Russell 1000 Index||1.5%||3.1%||6.0%|
|Russell 1000 Growth Index||2.2%||4.2%||11.7%|
|Russell 1000 Value Index||0.7%||2.0%||0.3%|
|Russell 2000 Index||-0.4%||2.7%||10.6%|
|MSCI World Index||1.0%||2.2%||3.0%|
|MSCI EAFE Index||0.2%||0.7%||-1.7%|
|MSCI Emerging Markets Index||1.7%||1.0%||-5.6%|
|STOXX Europe 600||-0.1%||1.3%||-1.8%|
|FTSE 100 Index||0.6%||0.3%||2.0%|
|CSI 300 Index||4.2%||0.0%||-12.0%|
|Fixed Income & Currency|
|Citigroup 2-Year Treasury Index||0.0%||0.0%||0.0%|
|Citigroup 10-Year Treasury Index||0.1%||0.3%||-2.4%|
|Bloomberg Barclays Municipal Bond Index||0.2%||0.4%||0.1%|
|Bloomberg Barclays US Aggregate Bond Index||0.2%||0.4%||-1.2%|
|Bloomberg Barclays Global Aggregate Index||-0.4%||0.0%||-1.4%|
|S&P/LSTA U.S. Leveraged Loan 100 Index||0.2%||0.5%||2.3%|
|ICE BofA Merrill Lynch U.S. High Yield Index||0.5%||0.5%||0.6%|
|ICE BofA Merrill Lynch Global High Yield Index||0.3%||0.6%||-0.9%|
|JP Morgan EMBI Global Diversified Index||0.9%||2.3%||-3.1%|
|JP Morgan GBI-EM Global Diversified Index||0.2%||1.1%||-5.4%|
|U.S. Dollar per British Pounds||-0.6%||0.0%||-2.4%|
|U.S. Dollar per Euro||-0.8%||-0.1%||-2.8%|
|U.S. Dollar per Japanese Yen||-1.7%||-1.5%||0.2%|
|Real & Alternative Assets|
|Alerian MLP Index||0.8%||1.1%||0.5%|
|FTSE EPRA/NAREIT North America Index||-0.9%||0.8%||2.5%|
|FTSE EPRA/NAREIT Global Index||-0.4%||0.5%||0.5%|
|Bloomberg Commodity Index||-2.7%||-4.0%||-4.0%|
|Gold (NYM $/ozt) Continuous Future||-1.2%||-1.1%||-5.2%|
|Crude Oil (NYM $/bbl) Continuous Future||-3.8%||-4.2%||17.5%|
Source: FactSet, Neuberger Berman.