Key Takeaways
- • Event-driven merger arbitrage spreads widened from roughly 3% in early March 2020 to more than 35% on average around the middle of the month, according to Morningstar Direct, as funding fears and selling pressure hit deal holdings.
- • Blackstone's buyout of Tallgrass Energy saw its spread jump from 8.9% on March 9 to 75.9% on March 16, yet the deal closed at the agreed price, leaving investors who bought at the peak with an approximate 75% return in about three weeks.
- • Value-factor exposure in alternative risk premium funds was a major detractor, with AQR Alternative Risk Premia (QRPRX) falling about 10% from Feb. 20 through March 23, 2020, and AQR Multi-Strategy Alternative (ASAIX) returning negative 22% in the first quarter.
- • Structured credit suffered steep losses as leveraged holders were forced to sell into margin calls and redemptions, with agency credit risk transfer (CRT) yields spiking to unprecedented levels, producing losses as high as 50% on the riskiest tranches and around 15% on better-protected bonds.
- • Short-volatility options strategies struggled as the VIX hit a record 82.7, surpassing the October 2008 high of 79.1, and losses on the CBOE S&P 500 PutWrite Index matched those of the S&P 500; managed-futures strategies were the notable exception, posting positive average returns.
Summary
Morningstar's analysis of liquid alternative strategies in the first quarter of 2020 finds that the equity sell-off that began in March spread into a broad spike in correlations across financial markets. By the end of the quarter, the S&P 500 had lost 20%, credit markets had suffered sharp losses, commodity prices had cratered, and implied volatility had reached unprecedented highs. Managed-futures strategies, which held up well during the global financial crisis, generated positive returns on average, while most other alternative strategies posted negative results.
In event-driven strategies, merger arbitrage was hit by both fundamental and technical pressures. The average all-cash acquisition target, which began March trading about 3% below its deal price, saw spreads widen to more than 35% around mid-month. Even low-risk deals were affected: LVMH's acquisition of Tiffany, which started the month at a spread below 2%, reached a discount of nearly 17% at the worst point. Leveraged buyouts fared worse, with Blackstone's Tallgrass Energy deal moving from an 8.9% spread on March 9 to 75.9% on March 16. Morningstar notes that deals have continued to progress as announced, and that many funds that bottomed mid-month recovered, though March still ranked among their worst months on record.
Alternative risk premium funds were hurt by their exposure to the value factor, which sold off more than market-cap-weighted indexes amid concerns about bankruptcy risk and lower dividend yields. Quality was the strongest-performing factor. AQR Alternative Risk Premia (QRPRX) fell about 10% between Feb. 20 and March 23, while AQR Multi-Strategy Alternative (ASAIX) returned negative 22% for the first quarter, hurt by both value exposure and event-driven spread widening.
Structured credit also came under heavy pressure. Forced selling by leveraged investors, including hedge funds, mortgage REITs and some mutual funds, pushed yield spreads to record or near-record levels. Agency CRT securities, which were created in 2013 to transfer mortgage credit risk from Fannie Mae and Freddie Mac to private investors, saw yields spike to unprecedented levels as forbearance and default concerns grew, with losses reaching 50% on the riskiest tranches. Morningstar observes that private vehicles with lock-ups are better placed to hold these less-liquid assets than open-end funds offering daily liquidity.
In options strategies, short-volatility managers suffered as expected given their crash-prone design, with the CBOE S&P 500 PutWrite Index losses matching those of the S&P 500. The VIX jumped from the mid-teens to the upper 40s within days at the end of February and reached a record 82.7, above the 79.1 high set in October 2008. Short-dated options were hit harder than longer-dated contracts, and the gap between their implied volatilities exceeded previously recorded highs.
In event-driven strategies, merger arbitrage was hit by both fundamental and technical pressures. The average all-cash acquisition target, which began March trading about 3% below its deal price, saw spreads widen to more than 35% around mid-month. Even low-risk deals were affected: LVMH's acquisition of Tiffany, which started the month at a spread below 2%, reached a discount of nearly 17% at the worst point. Leveraged buyouts fared worse, with Blackstone's Tallgrass Energy deal moving from an 8.9% spread on March 9 to 75.9% on March 16. Morningstar notes that deals have continued to progress as announced, and that many funds that bottomed mid-month recovered, though March still ranked among their worst months on record.
Alternative risk premium funds were hurt by their exposure to the value factor, which sold off more than market-cap-weighted indexes amid concerns about bankruptcy risk and lower dividend yields. Quality was the strongest-performing factor. AQR Alternative Risk Premia (QRPRX) fell about 10% between Feb. 20 and March 23, while AQR Multi-Strategy Alternative (ASAIX) returned negative 22% for the first quarter, hurt by both value exposure and event-driven spread widening.
Structured credit also came under heavy pressure. Forced selling by leveraged investors, including hedge funds, mortgage REITs and some mutual funds, pushed yield spreads to record or near-record levels. Agency CRT securities, which were created in 2013 to transfer mortgage credit risk from Fannie Mae and Freddie Mac to private investors, saw yields spike to unprecedented levels as forbearance and default concerns grew, with losses reaching 50% on the riskiest tranches. Morningstar observes that private vehicles with lock-ups are better placed to hold these less-liquid assets than open-end funds offering daily liquidity.
In options strategies, short-volatility managers suffered as expected given their crash-prone design, with the CBOE S&P 500 PutWrite Index losses matching those of the S&P 500. The VIX jumped from the mid-teens to the upper 40s within days at the end of February and reached a record 82.7, above the 79.1 high set in October 2008. Short-dated options were hit harder than longer-dated contracts, and the gap between their implied volatilities exceeded previously recorded highs.
Go deeper than the headline
Research every firm in this story, track the ones that matter and get the daily briefing — free for 7 days.