Higher volatility puts Low Beta strategies in asweet spot

With the U.S. equity market under selling pressure in early September, the MSCI World has registered its worst week since late March, down almost -1.5%.

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This occurred in a context where the probability of an escalation of trade tensions between the U.S. and China has increased. The deadline to make public comments on $ 200 billion of proposed U.S. tariffs on China’s imports was last Thursday. Early August, the U.S. President signaled the tariff could be as high as 25%. Meanwhile, EM assets continued to sell off.

In the hedge fund space, low beta strategies outperformed last week. Merger Arbitrage, which has structurally a low beta versus equity markets, was the sole strategy in positive territory. Positive contributors to performance include the Aetna vs. CVS deal whose deal spread tightened on the back of media reports suggesting the DoJ may approve the deal within the next few weeks. The DoJ is also reportedly close to approving Cigna’s acquisition of Express Scripts, a significant deal in Merger Arbitrage portfolios. Then, the Sky vs Comcast deal spread also edged lower in early September, contributing positively to performance. Meanwhile, CTAs were flat despite their long U.S. equities positions and Fixed Income Arbitrage was slightly down.

Strategies with a higher market beta, such as L/S Equity and Special Situations were down 1.2% and 0.8%, respectively. Over the summer, L/S Equity strategies took more directionality by increasing marketbeta, they also recently rebuilt their tilt to cyclicals, which was harmful early September.

In terms of investment recommendations, we maintained an overweight stance on Merger Arbitrage. The strategy appears to be perfectly fit for current market conditions, where downside risks remain elevated amidst high political uncertainty and rich valuations across equity markets. Deal spreads have narrowed lately but the strategy maintains its appeal thanks to its low volatility in returns and low correlation to traditional assets.

The beta of Merger Arbitrage returns versus the MSCI World has historically been below 10%. Finally, while M&A activity will probably be softer in Q3 compared to the same quarter in the past two years, it is still strong in absolute terms.

Lyxor Research September 2018

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