HFS Bulletin

US focused equity hedged strategies generally generated positive performance in May. The overall theme reverted back to risk-on last month as a series of benign labor and inflation prints rekindled hopes of potential rate cuts later this year. Market sentiment softened somewhat later in the month following some hawkish commentary from Federal Reserve Board members, though this was largely offset by AI-inspired optimism stemming from solid earnings prints. Manager performance tended to be idiosyncratic in nature with the beta component helping most directionally oriented generalist and tech managers while several healthcare managers struggled with stock specific issues. It was the lowest alpha month of the year and negative by some measures as long/short spread was challenged by broader weakness in less crowded longs (rather than the typical case of crowding serving as the proxy for alpha) and some squeeze in select shorts at times. From a factor perspective, it was the mirror image of April with realized volatility being the largest positive driver, quality lagging as momentum eased on short leg strength. Energy posted a marginal decline driven largely by the bearishly perceived OPEC meeting. Utilities was the leading sector mostly due to the excitement around AI-related power demand. “Roaring Kitty” returned, leading to renewed focus on meme shorts; while funds generally have limited direct exposure to GME, some modest collateral impact was felt on the short side and from factor reversal.

European focused equity hedged strategies generated mostly positive performance in May. Alpha generation was mixed in a month where long/short managers generally had negative alpha relative to the MSCI Europe. Energy funds or generalist funds with high exposure to technology tended to outperform during the period. By sector, renewables, semiconductors, financials, and telecommunications drove market gains while travel and leisure, as well as autos and oil, lagged markets. Factor-wise, growth and dividend yield names benefited while quality and volatility both lagged once again. Prime brokers reported that after being the most net sold region in April, Europe was the most net bought region in May, with the largest net buying the region has seen since mid-year 2023. There was a 3.4 ratio of long buying to short selling, driven primarily by single names, though macro products were net bought as well. Financials and industrials were the most net bought sectors, while consumer staples was the most net sold.

Asian Equity Hedged strategies generated mostly positive performance in May. Overall results were driven by China, Japan and AI related themes. The Japanese market was largely range bound for the month on concerns regarding the direction of US rates as well as expectation on BoJ action. The Nikkei slightly underperformed TOPIX, mostly due to investors selling futures. For China, the strong market rebound since April continued until May 20th where the market gave up most of the gains. The onshore market, down in May, continued to be weaker than the offshore market. Finally, while there were stronger policy signals from the government, those positive signals were offset by investor profit taking and mixed macro data releases.

HFRI Equity Hedge Total Index:

Fixed income relative value strategies generally produced positive performance in May. Overall, managers continued to maintain low risk levels / high cash and held onto their tail hedging strategies. Macro and yield curve trading strategies were additive, particularly in the US and Japan, as directional shorts in Japanese rates performed well for the second month in a row and added to gains for some managers. US and global micro relative value trading was a small positive for most managers through the core cash futures basis and bond RV strategies. Inflation trading also did well for some managers. Swap spread trading was mixed and some managers suffered from tail hedges and basis swap wideners.

Cap structure / volatility arbitrage strategies generated mostly positive performance in May. The period saw solid results from the convertible arbitrage cohort, while capital structure approaches produced more mixed results. On balance, interest rate and credit hedges detracted from the managers’ returns last month. Primary convertible bond volumes were almost double the seasonal historic average last month, amounting to USD 18.0bn. Notably, while the US offered the most volume at USD 10.5bn, a sharp rebound from April’s lull on the back of Q1 earnings blackout, Asian issuers priced USD 7.0bn of new paper from Alibaba and JD.com, the region’s highest monthly total volume on record since 1998. Europe and Japan, on the other hand, were quiet, having launched USD 244m and USD 318m, respectively. The significant new issuance volumes put secondary market valuations under pressure towards the end of the month. In May, non-investment grade convertible bond spreads widened 45bps to 538bps, and the spread between non-investment grade converts and the Bloomberg HY ‘B’ Index increased to +259bps from +213bps last month.

Merger arbitrage and event driven strategies produced mostly flat to positive performance in May. Over the course of the month, the market saw a notable improvement in non-solicited, competitive bid/bump and hostile event activity, particularly in Europe. Sector-wise, technology and energy continued their lead, representing almost half of the deals announced year-to-date. Sponsor activity picked up last month, as did the take-private activity. Lastly, cash utilization rates remained above long-term averages. Equity Capital Markets managers had another positive month in May, despite a relatively quiet month for IPOs, with very few sizeable deals coming to market. Block and follow-on activity in the US was strong, led by Haleon, and also some large landmark deals in Europe, which tended to drive the managers’ performance.

Agency MBS sub-strategies generally produced positive performance in May. The sub-strategy’s two main allocations were the top performing investments for the Credit/Income platform during the month. The strategy benefited from positive fundamentals as prepayment speeds remained relatively slow. In total, returns were primarily driven by carry and modest spread tightening on mortgage derivatives. In addition, managers with long biases to the mortgage basis outperformed.

Quantitative equity strategies overall generated positive performance in May. The Market Neutral cohort saw results driven mostly by beta gains despite some evidence of negative long short spreads.

Short Interest, volatility, Short Concentration, sector tilt (Info Tech and Industrials), and China were among the largest alpha detractors in May, partially offset by gains from crowdedness (both short and long), profitability, medium-term momentum, and dividend yield. Analyst sentiment generated small but positive returns in May. Momentum was broadly challenged last month while reversal saw positive returns – reversing the pattern seen in April. Market vs between sectors daily dispersion moved up month over month, suggesting higher importance of micro drivers and a relatively large alpha pool. We also observed an increase in the within sector vs market daily dispersion, suggesting moderating levels of intra-sectors correlation were supportive of sector neutral alpha extraction. Gap between dynamic and static multi factors model suggest factor timing was more challenging this month. Quant Equity gross and net leverage was lower than recent peaks, but remained historically elevated.

HFRI Relative Value Total Index:

Corporate credit strategies generally generated positive performance in May. The Corporate Long Biased sub-strategy generated positive total returns in May. All funds were up during the month and ultimately generated profits from a combination of positive carry and spread tightening. Idiosyncratic gains were relatively limited last month although investments in high yield bonds and leveraged loans were the primary contributors. The Corporate Long/Short sub-strategy overall produced a positive result. The majority of managers generated profits in May. Long investments were the main contributors to performance. Conversely, short investments detracted during the month as a result from spread tightening in most segments of the market. Those managers with net long biases outperformed relative to those managers with net short portfolio structures. Corporate credit markets generated positive total returns as spreads tightened for most segments of the market and fixed rate debt outperformed as a result of the rally in rates.

Asset backed strategies generally generated positive performance in May. Every fund generated a positive return during the month as most managers were up between +0.75% and +1.50% for the month. Long investments were the main contributors as positive carry accounted for the vast majority of profits. Investment in RMBS and CLOs outperformed during the month although investments in SRT and Reg Cap were also additive to performance.

Cat bond and collateralized reinsurance strategies generally generated positive performance in May. The primary driver of returns was premium income and spread movements. Spread widening did more than offset the premium carry for our cat bond manager as new issue supply volume exceeded that of maturing bonds during the month, causing some indigestion. Spreads also typically widen during the spring as a result of the oncoming hurricane season and increased concern over a very active hurricane season likely exacerbated this trend. As such, pricing within the cat bond market generally seemed more attractive as spreads widened from where they were at the start of the year. Our collateralized reinsurance manager is not subject to spread movements and therefore was able to benefit from the positive carry from premium income.

HFRI ED: Credit Arbitrage Index