Monday, July 02, 2007

June post-mortem: the return of alpha (kind of)

Another month is in the books, and for once, it wasn't (all) about buy and hold. Thanks to a bond market rout and renewed subprime concerns, equity investors had to work for their money in June, as the S&P 500 fell for the first month since February. Currencies were a different proposition, however, as the naive carry basket delivered sparkling returns, proving that beta ain't quite dead yet.

Macro Man generally prospered during June, notching the best monthly performance in the blog portfolio's short history. While he was able to capture virtually all of the return on offer from FX carry (less a bit of transactional friction late in the month), he also managed to sidestep the equity market noise and profit quite handsomely from a number of stock market bets. All told, the portfolio rose 2.72% in June, taking the year-to-date performance to 8.65%. After generating 5% during April and May, the equity beta portfolio took a step backwards in June, shedding 1.23%, its worst month of the year. Somewhat surprisingly, however, FX carry notched its best of the month of 2007, as the beta basket made 1.77%. Financial markets have become so accustomed to high levels of correlation between risk asset trades that it now seems legitimately surprising to observe diversification at work. Macro Man isn't complaining, however, and is more than happy to accept the 0.55% of positive performance generated by the beta portfolio in aggregate. The performance was actually somewhat better when one considers that the SPY went ex-dividend during the month, but only pays out on the last day of July, which should add another 0.28% to equity beta performance this month.

The real story of June was the return of alpha, however. Macro Man's alpha portfolio broke a three month losing streak to generate its best performance of the year. the returns were almost entirely concentrated in equities, where the alpha portfolio rose 2.12% in June. Returns were split amongst three core equity alpha bets. The S&P futures option overlay, combining maturing June options with a new July risk reversal, add 0.43% of return. This was essentially an offset against the long beta position. The long Brazil ETF also generated 0.43% of return, justifying the underlying view that equites are the best play in Brazil at the moment. The home run trade, however, was the short homebuilder position versus the SPX. The XHB ETF shed 15% during June, versus 1.9% for the SPY. All in, the cash and option position made 1.23% during the month.


Macro Man believes that the position is worth keeping until he sees evidence that hombuilders are adjusting to reality by shedding labour and reducing supply. That having been said, the index has come a long way in a straight line, and volume numbers are beginning to show signs of accumulation under $31. Macro Man may therefore look to trim his short cash position this week, as there may soon be a reasonable chance of a bounce.
Elsewhere, FX and fixed income alpha both registered tiny positives for June. FX was up quite handsomely for most of the month, but last week's EUR/USD rally knocked most of the profit out of the Powerball strip of one touches. An ill-timed purchase of USD/JPY straddles also shed a bit of profit. All in, FX alpha bets returned 0.02%, demonstrating once again that beta remains king in currency markets. The fixed income alpha portfolio went a basis point better, returning 0.03%. Losses on the "clarion call" bond purchase and long TIPS long were offset by modest gains on short JGBs and the SGD payer position. Macro Man avoided commodities altogether after hideous losses the previous three months.
Subprime looks set to remain on center stage in July, for this week at least. But the way that themes and regimes seem to switch on virtually a daily basis, by the end of July the market's thoughts, greed, and fear could completely revolve around something that isn't on the radar today. Stay tuned.

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