Chidem Kurdas
It seems the riskier, the better—to a large extent. Event-driven managers that trade on mergers, acquisitions, myriad business troubles, bankruptcies and various corporate actions – highly uncertain investments that are illiquid, that is, difficult to sell – had the highest return among hedge funds during the first six months of 2014.
Not surprisingly, investors have been putting their money in event-driven funds, which may account for a growing share of portfolios.
Event-driven made %5.75 through June according to the Credit Suisse index, beating hedge funds as a whole by a respectable margin. However, like hedge funds in general, the diverse strategies that come under the rubric of event-driven were defeated by the stock market—where shareholders still danced, bringing the S&P 500 up by 7.14%.
Why is wobbly paper so profitable at this time? Almost all fingers point to central banks. A report from Lyxor describes central bank policies’ boosting effect on a range of risky investments, from activist stocks, leveraged buy-outs and private equity to distressed issues, which rose 3% to 4% on average last month.
While the U.S. Federal Reserve is winding down its monthly purchases of bonds, the European Central Bank promises to become more accommodating.
On the whole, central banks have not only injected loads of money into the global economy, they’ve made it clear that they will do even more if trouble shows up—as the most recent remarks by Janet Yellen confirm. They’ve created a supportive environment for all financial assets but especially for difficult-to-dispose-of securities that need support.
Illiquid asset premiums “were supported by assurance of prolonged accommodative liquidity,” Lyxor research chief Philippe Ferreira points out.
Distressed managers had bought the debt – and sometimes the equity – of shaky banks and other financials. They also invested in media and communications companies. These securities gained substantially in recent months. So distressed funds are at the very top of the performance lineup, trumping other event-driven investment programs.
That’s past performance. This month a troubled bank, Portugal’s Banco Espirito Santo, made markets wobble.
In response central bankers may pull yet more money out of their collective hats, ensuring that the risk party goes on. Indeed, a survey of hedge fund managers by Lyxor found that the majority expect central banks to remain extremely accommodative, with the ECB and the Bank of Japan engaging in bond buying – quantitative easing – in the second half of this year.
Only 47% said the Fed will raise rates in the next 12 months. Despite those upbeat views, 65% of the respondents do not expect the American credit rally to continue. The end of the rally would bring some of the risk home with a hangover.
Tags: Banco Espirito Santo, Credit Suisse, Lyxor
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