O’Connor Global Multi-Strategy Alpha Quarterly Letter

For anyone travelling over the Easter holiday, labor strikes and weather disruptions served as a reminder that the best laid plans don’t always work out and you have to be flexible and adaptable.

The events and performance of financial markets this year have delivered a similar message to investors as we need to be dynamic and respond to a rapidly changing macro backdrop. For example, looking at Q1 2023 S&P 500 returns by sector, compared to 2022, we can see how performance has been largely turned upside down - a scenario that few were predicting at the start of the year.

The collapse of Silicon Valley Bank (SVB) and turmoil in the wider banking system illustrate that the rapid monetary tightening cycle of the last few quarters has significant consequences for financial markets. The MOVE Index of Treasury volatility hit levels in March last seen during the GFC, although we have seen a rapid sell-off in volatility across asset classes in subsequent weeks. That said, we do think the speed at which authorities have been willing to intervene to stabilize markets in potentially critical situations like this one has been noteworthy and limits contagion risk.

Source: Data from Bloomberg, UBS Asset Management analysis. As of April 16, 2023.

We are mindful of, and in some strategies positioning for, the future fallout of these recent events. Even prior to SVB’s collapse, we have been seeing a tightening of financial lending standards which will continue to impact parts of the economy like manufacturing directly. The C&I loan survey moving higher indicates banks tightening credit, which typically leads ISM new orders lower.

Source: Refinitiv Datastream, Credit Suisse Research as of 21 April 2023 for the time frame of May 15, 1990 – February 15, 2023

In the recent National Federation of Independent Business (NFIB) survey conducted during March 9% of US small businesses reported their last loan was harder to get than in previous attempts – the most significant deterioration in over two decades.

Source: BofA Global Research, Haver as of March 31, 2023

When you compare the actual interest rate paid on short-term loans by small- and medium-sized business (SMB) borrowers to the high yield index coupon rate, rarely has the spread been wider. Such instances have often coincided with more painful economic periods.

Source: Bloomberg, Jefferies as of March 31, 2023

One problem for the future development of the US economy is the tightness in the country’s labor market is being exacerbated by the hiring needs of smaller businesses: SMB labor demand is nearly four times of larger companies.

Source: Bloomberg, Jefferies as of February 28, 2023

In some of our equity strategies we have been expressing a more cautious view on names more tied to the US economy, as we see pockets of weakness appearing in credit card data and corporate commentary. Industrials and materials companies – companies reliant on low- and middle-income consumers or the easy availability of credit – are specific focal points. In contrast, we continue to see strength in the high-end consumer areas like luxury, which are supported by China’s reopening and related travel trends. We also see opportunity in cyclicals, especially within energy transition, where there appears to be visible and de-risked earnings growth for the coming years.

The recent divergence between the German DAX Equity Index and German Bunds intrigues our European team. We are finding more interesting opportunities on the long side in more defensive bond proxy subgroups like consumer staples, infrastructure and utilities, while worrying about 2023 and 2024 revenue and margin expectations for a number of German industrial cyclicals.

Source: Data from Bloomberg, UBS Asset Management analysis. As of March 31, 2023

In credit, the US regional banking issues are leading to tighter and higher priced credit, and a greater dispersion in the availability of credit for corporates, which we believe should help our strategies. Credit and credit betas have underperformed equities, and at a single issuer level that also presents interesting relative value opportunities. Companies are spending more time scrutinizing their debt stack and financing plans – which we think can help some of our idiosyncratic situations in convertibles as issuers look to buy back certain maturities. Furthermore, we have seen how recent M&A activity can also catalyze value for our holdings.

In broader merger arbitrage, we have seen a notable pickup in recent weeks of both strategic- and PE-led activity, and some more favorable deals close amid anti-trust news flow. Yet the complexity of many deals lately has meant a blanket approach to harvesting merger arbitrage risk premia has not been straightforward, and requires a more discerning and discretionary approach.

We continue to expect a rapidly evolving macro landscape with varying ramifications for different industries and corporates, which empowers our teams’ idiosyncratic alpha generation process. The exact journey for markets from here remains uncertain, plans will need to be changed and adjusted – but we are prepared to react and adapt quickly.

As always, we thank you for your continued support.