Alternatives Market Outlook H2 2018

STONE MOUNTAIN CAPITAL RESEARCH PERSPECTIVE VOL.88

Figure 1. Stone Mountain Capital In-House Indices vs. Major Benchmark Indices Hedge Funds and Long Only in H1 2018, Stone Mountain Capital Research SMC strategy indices are not investable products but are used as indication of our managers’ performance and are calculated with the equally-weighted method.

H1 2018 was rather disappointing for hedge funds, seeing outflows by end of the second quarter. According to data from Hedge Fund Research, investors invested more capital in equity hedge strategies, while they redeemed from event-driven, macro and relative value strategies. The shift in strategies was driven by the rising concerns over potential trade war, monetary policies from central banks, including interest rate decisions, and political uncertainty in major European countries. Performance was strong for strategies focusing on tech, and our equity long short manager sits on the top of our top-performing table. The divergence in central bank policies has favoured macro strategies focusing on traditional relative value bets and event-driven strategies that have catalyst elements. Our top performing strategies table consists of discretionary macro focusing on relative value trading and equity strategies that are engaged in activism and have a niche in US equities markets.

Our in-house strategies in credit, equity and fund of funds, as measured by our indices, have performed better in the first half of the year than their traditional and alternative peers. Tactical trading is still lagging due to the struggling performance of the actively managed altcoin strategy this year mainly driven by falling bitcoin prices. Equities are the top performing and the bucket that has the most representatives in the top-5 performing table, followed by credit/fixed income strategies.

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RESEARCH PERSPECTIVE VOL.88 AUGUST 2018 Alternatives Market Outlook H2 2018 H1 2018 was rather disappointing for hedge funds, seeing outflows by end of the second quarter. According to data from Hedge Fund Research, investors invested more capital in equity hedge strategies, while they redeemed from event-driven, macro and relative value strategies. The shift in strategies was driven by the rising concerns over potential trade war, monetary policies from central banks, including interest rate decisions, and political uncertainty in major European countries. Performance was strong for strategies focusing on tech, and our equity long short manager sits on the top of our top-performing table. The divergence in central bank policies has favoured macro strategies focusing on traditional relative value bets and event-driven strategies that have catalyst elements. Our top performing strategies table consists of discretionary macro focusing on relative value trading and equity strategies that are engaged in activism and have a niche in US equities markets.   Credit/Fixed Income Strategies YTD 2018 Annualised Return Annualised Volatility Sharpe Ratio Sortino Ratio SMC Credit Strategy Index 3.62% 8.80% 4.71% 2.06 0.64 Credit Suisse Fixed Income Index 1.48% 5.15% 5.05% 0.62 -0.28 HFRX Credit/Fixed Income Index 0.29% 5.48% 5.10% 0.68 -0.26 UAIX Fixed Income-Global (UCITS) -1.04% 1.05% 1.44% 0.73 0.92 BofA ML US Corporate Master Index -2.13% 7.37% 6.33% 0.85 -0.16 Equity Strategies YTD 2018 Annualised Return Annualised Volatility Sharpe Ratio Sortino Ratio SMC Equity Strategy Index 4.01% 13.02% 12.96% 0.92 0.44 Credit Suisse L/S Equity Hedge Index 0.66% 8.75% 8.92% 0.76 -0.05 HFRX Equity Hedge Index 0.24% 5.33% 7.78% 0.42 -0.21 UAIX L/S Equity (UCITS) 1.75% 4.41% 4.68% 0.94 1.25 S&P 500 1.95% 7.43% 14.29% 0.38 -0.09 Tactical Trading Strategies  YTD 2018 Annualised Return Annualised Volatility Sharpe Ratio Sortino Ratio SMC Tactical Trading Strategy Index -5.81% 24.28% 24.56% 1.12 0.35 Credit Suisse Global Macro Index 1.85% 9.72% 8.68% 0.89 -0.01 HFRX CTA Index -3.64% 3.62% 9.44% 0.17 -0.24 HFRX RV Volatility Index -1.55% 4.31% 4.60% 0.50 -0.42 CBOE Eurekahedge RV Volatility Index -0.65% 8.47% 3.71% 1.74 -0.40 UAIX CTA (UCITS) -3.91% 2.98% 8.99% 0.33 0.46 Fund of Hedge Funds Strategies YTD 2018 Annualised Return Annualised Volatility Sharpe Ratio Sortino Ratio SMC FoHF Strategy Index 2.55% 6.37% 6.89% 0.65 -0.18 HFRI FoHF Index 1.02% 6.61% 5.42% 0.84 -0.34 UAIX Multi-Strategy (UCITS) -2.86% 3.06% 3.26% 0.94 1.13 SMC Single Manager Cross-Asset Index -0.74% 14.93% 13.37% 1.44 0.49 SMC Cross-Asset Index -0.64% 14.30% 12.89% 1.38 0.44 Figure 1. Stone Mountain Capital In-House Indices vs. Major Benchmark Indices Hedge Funds and Long Only in H1 2018, Stone Mountain Capital Research SMC strategy indices are not investable products but are used as indication of our managers’ performance and are calculated with the equally-weighted method. Our in-house strategies in credit, equity and fund of funds, as measured by our indices, have performed better in the first half of the year than their traditional and alternative peers. Tactical trading is still lagging due to the struggling performance of the actively managed altcoin strategy this year mainly driven by falling bitcoin prices. Equities are the top performing and the bucket that has the most representatives in the top-5 performing table, followed by credit/fixed income strategies. Figure 2. Net Asset Flows for Hedge Funds for Q2 2018, Source: Hedge Fund Research, Bloomberg   Inflows to equity hedge strategies are product of economic growth and fear of interest rate rise, which may affect the bond markets. The importance of active management is highlighted in times of such events as evidenced in Figure 3. This environment favors macro managers who eye on volatility from policies and political events and relative value trades across fixed income and currency markets. Long/short credit managers are expected to attract more interest due to better duration risk management within institutional portfolios. Figure 3. HFRI Fund Weighted Composite Index Alpha at Different 5-Year U.S Treasury Yield Levels from January 1991 to May 2018, Source: HFR, Franklin Templeton   The agenda of tax cuts and repatriation of cash combined with reshaping of media and healthcare industries due to M&A mega deals constitute a prolific environment for merger arbitrage, catalyst and activist investing. Credit Suisse survey for hedge funds underline the strong appetite for discretionary macro, equity sector-specific and volatility arbitrage strategies. Figure 4. Strategy Preferences for 2H 2018, Source: Credit Suisse   Private debt continues seeing inflows mainly due to middle market lending strategies in the U.S. and Europe. The risk-return profile of the asset class attracts institutional capital and has reached record levels of dry powder. Investors will focus more on senior lending in the current late credit cycle state as a downside protection in their portfolio. Direct lending vehicles constitute the primary alternative to banks, which are still struggling with regulations and increased number of non-performing loans. Figure 5. Dry Powder of Private Debt, Source: Preqin   But investors should look beyond direct lending to diversify their private debt portfolio due to less attractive opportunities in the space combined with increased flows, deterioration of credit underwriting and yield compression in the space. Since 2014, over $450bn were raised to pursue opportunities in the private debt space, as investors are looking for uncorrelated sources of returns with low volatility. Figure 6. Private Debt AuM, Source: Preqin   Private equity is resembling private debt as both asset classes have accumulated institutional capital looking for attractive opportunities to deploy. Private equity firms have been recently competing with venture capital and they have invested a lot in fintech and other industries that are susceptible to disruption such as healthcare. Growth deals have been almost one fourth of the private equity universe, while buyout sizes continue to increase mainly driven by large sums of dry powder and fundraising momentum. Figure 7. Private Equity Growth Deals until June 2018, Source: Pitchbook Figure 8. Median and Average Buyout Size per Year until June 2018, Source: Pitchbook   Private equity remains an asset class for the larger AuM general partners accumulating more capital than heir undersized peers because investors feel their investments are safer and their capital will be easier deployed due to the large number of opportunities presented to them. According to data from Cambridge Associates, Thomson One and McKinsey, mega funds have outperformed their private equity and public market peers since 2008, justifying the choice of investors despite the recent scrutiny over fees. Real estate has diachronically lured institutional capital due to inflation hedge and income generation characteristics. The main concern remains the high level of prices which led to a slowdown in deal activity as per Figure 9. Figure 9. PERE Deals, Q1 2014 - Q2 2018, Source: Preqin   Concerns about high valuations, record dry powder and geopolitical uncertainties affected also the strong fundraising momentum that real estate funds have developed recently. Value-added strategies have been the main allocation pole for investors, who also spot opportunities in European and UK commercial debt space favoring the view of a late cycle in the market. Fintech is enhancing real estate lending and we expect more real estate lending to be originated online. Figure 10. Real Estate Fundraising and Number of Funds Source: Preqin   Crypto assets suffered a bad H1 2018 due to heavy market correction. The market capitalisation has nearly halved for the existing 1845 cryptocurrencies to just $209bn. More than 800, though, worth less than a penny in a largely concentrated market as Bitcoin and Ethereum account for 70% of the market. Currently, Bitcoin is trading at $6,500, which is close to the year’s lowest point and many observers believe the price will pick up in H2 2018. Ethereum has reached year’s low trading at less than $300 but it is believed to increase due to the underlying use of blockchain technology. Regulatory challenges will be the main topic in H2 2018 as improvements in the market will offer upside to the well-established and well-capitalised cryptocurrencies. STONE MOUNTAIN CAPITAL   Stone Mountain Capital is an advisory boutique established in 2012 and headquartered in London. We are advising 30+ best in class single hedge fund and fund of fund managers across equity, credit, and tactical trading (global macro and CTAs). In private equity and private debt, we advise 10+ general partners across the sectors real estate, infrastructure / real assets and capital relief trades (CRT) by structuring funding vehicles, rating advisory and private placements.As per 19th July 2018, Stone Mountain Capital has total alternative Assets under Advisory (AuA) of US$ 52.3 billion. US$ 48.2 billion is mandated in hedge fund AuM and US$ 4.2 billion in private assets (private equity / private debt / real estate) and corporate finance. 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