Source: J.P. Morgan Asset Management.
Mixed Performance Across Event-Driven Factors
It was a very rocky quarter for the merger arbitrage factor. Spreads 1 widened as volatility surged at the beginning of February. No sooner had the factor begun to recover mid-month than a negative idiosyncratic event occurred toward the end of February. Merger arbitrage spreads continued to widen in March as a wave of protectionist and antitrust fears negatively impacted five deals in particular. However, after a difficult January, our expanded suite of event-driven factors delivered gains in March and ended the quarter close to positive territory, making up for some of the losses from merger arbitrage. Share repurchases in particular performed well, even though this factor is known to have a modest correlation to the value factor.
Corporate activity levels remained below their long-term average, limiting the opportunity to gain exposure to event-driven factors without sacrificing diversification. We had expected to observe an increase in activity on the back of corporate tax changes in the U.S. (particularly around repatriation of overseas cash), and, indeed, we are beginning to see that theme play out with respect to share repurchases. Although merger arbitrage activity has been fairly quiet, spreads are now 30% above their recent averages (up from 9% to 12% on an annualized basis); in addition, more than 90% of deals are friendly, supporting the prospects for performance going forward.
Momentum Factors Suffer from Sharp Reversals
A transition away from accommodative policy by central banks has led to losses across macro factors. Time-series momentum especially suffered, due to long positioning across equity markets heading into the spike in volatility in February and a shift from long to short positioning across fixed income markets just as the rise in rates reversed. Carry factors were slightly positive, with gains in FX markets offset by losses in fixed income and commodity markets.
The spread between high yielding and low yielding currencies remains below its long-term average (particularly for G10 currencies), as does the difference in term premium across government bonds. Although this suggests a diminished opportunity to capture carry in those markets, rate normalization could improve the opportunity set. Additionally, the difference in roll yield between high carry and low carry commodities increased. Regarding momentum factors, dispersion in price moves across currencies and commodities worsened. However, the number of significantly trending markets stayed at healthy lev-els and we saw a shift in positioning, from long to short across fixed income markets through February and from long to short across equity markets by the end of March.
Concluding Remarks
When all is said and done, a volatile quarter largely improved the opportunity set for factors, with potential catalysts in place across the equity, event-driven and macro spaces. As always, we believe in diversifying across a broad range of compensated factors while minimizing exposure to uncompensated risks.
Factor Opportunity Set
The table below summarizes our outlook for each of the factors accessed by the Quantitative Beta Strategies platform. It does not constitute a recommendation but rather indicates our estimate of the attractiveness of factors in the current market environment.
Source: J.P. Morgan Asset Management; for illustrative purposes only.
*Other: Conglomerate discount arbitrage, share repurchases, equity index arbitrage, post-reorganization equities and activism.
1The difference between the target company’s stock price and the announced acquisition price.
Glossary
- Equity momentum: long/short global developed stocks, based on price change and earnings revisions; sector and region neutral
- Equity quality: long/short global developed stocks based on financial risk, profitability and earnings quality; sector and region neutral
- Equity size: long/short global developed stocks based on market capitalization; sector and region neutral
- Equity value: long /short global developed stocks based on book-to-price, earnings yield, dividend yield, cash flow yield; sector and region neutral
- Merger arb: long target company and short acquirer (when offer involves stock component) in announced merger deals across global developed markets
- Event-driven (other): conglomerate discount arbitrage, share repurchases, equity index arbitrage, post-reorganization equities and shareholder activism
- Macro carry: FX G10 carry, FX emerging market carry, fixed income term premium, fixed income real yield, commodity carry
- Macro momentum: FX cross-sectional momentum, commodity cross-sectional momentum and time series momentum across equity, fixed income and commodity markets
For more market trends, visit ETFTrends.com.