Marshall Wace Has Strong Q2; Remains Exposed To China

Marshall Wace had a strong second quarter, as the long short hedge fund delivered 3.15 percent returns with a 6.16 percent level of volatility, as measured by standard deviation, according to a letter to investors reviewed by ValueWalk.

Asia big winner for Marshall Wace in Second Quarter

Asian exposure during the period was credited for much of the return alpha, as the TOPS Pan Asia, Pan Asia Fundamental and the TOPS Japan strategies were three of the top four strategy subsets in terms of both gross performance and alpha generation. China, the U.S., Japan and Hong Kong are the top geographic regions in terms of global alpha on the quarter.

The fund’s net China exposure was interesting. Starting at just 2 percent on October 1, 2014, exposure peaked near the end of April and has been steadily declining, representing just less than 4 percent as of July 15, roughly following the trend higher and then selling before Chinese stock indexes started to fall in June.

The fund noted that Chinese consumer spending has “barely in contrast to the steady slowdown of the export/manufacturing economy.” Real wage growth is steady, and this supports consumer spending. While the consumer is strong, industrial production is slowing while manufacturing faces steep price deflation due to strong RMB and production over capacity.

“China’s biggest challenge is highly indebted corporate sector struggling with overcapacity (in many sectors) and increasingly expensive FX rate,” they noted.

Marshall Wace heavily exposed to pharma and biotech, the hot sector

In terms of industries, banks, capital goods, consumer stocks, transportation and utilities were the best segments for alpha generation. Energy and real estate were the worst contributors.  The long contribution to performance was 5.9 percent while the shorts subtracted -1.1 from performance.

Going forward, the Eureka fund is heavily exposed to pharma and biotech, the hot industry of late on increased merger and acquisition chatter, closely followed by bank exposure, with telecom, insurance, media and materials in the top exposure category but distant by more than half the pharma and biotech exposure. Underweights or shorts include consumer services, semiconductors, with heavy shorts in energy, utilities and food and Staples, Inc. (NASDAQ:SPLS) retail.

In terms of geographic exposure, China and Germany remain the highest regions while Japan, the UK and France remain positive standouts, while the USA is the strong standout on the short side.

Marshall Wace economic outlook: reflation and liquidity watchwords

The hedge fund sees liquidity easing among the G4 nations, particularly in the Eurozone and Japan, with inflation normalizing in the 1.5 percent range. In the U.S. they note that services inflation is already higher than the 2 percent Fed threshold. Good deflation relative to China is the most significant challenge relative to achieving a normalized inflation level, they observe.

In a “reflationary backdrop” the fund predicts “cyclicals outperform growth / yield,” with Europe and Japan appearing best positioned. Reduced oil related capital expenditures and a strong U.S. dollar have been headwinds to growth reflation.

In a reflationary environment, money finds its way into financials and cyclical areas from defensive and high growth issues as a positive feedback look occurs through a steeper yield curve, rising margins and improving credit demand, the report noted.

Marshall Wace

Housing has broken out of a seven year range recently, as household formation spiked above the 1,000 top to touch near 2,000 before backing off just below 1,500. Housing starts have been slowly trending higher. Compare this to the post crisis average household formation of 663 and housing starts at 773.