Hedge funds welcome chance to profit from market chaos

Funds of hedge funds say market unrest and uncertainty around the world have handed them the opportunity to finally capture alpha. And the new volatile conditions are set to sort the winners from the losers.
Hedge funds welcome chance to profit from market chaos

Volatile market conditions have been welcomed by fund of hedge fund managers, who say it gives them a chance to profit from wild price swings and global uncertainty.

Amid a summer of Chinese equity and currency turmoil, eurozone crisis and worries over a rise in US interest rates, 2015 has turned into a year of profit for the funds, which perform best in such conditions.

Fund of hedge funds have had a good year. Eurekahedge’s fund of funds index is up 3.55% year to date, for example, already outpacing the full-year rise of 3.44% in 2014.

“The market is shifting from beta to alpha finally,” said UBS Hedge Fund Solutions’ global head of product specialists Jerome Raffaldini during a recent visit to Hong Kong.

And the new conditions will allow the winners to be sorted from the losers, pointed out Mats Sjostrom, executive director of Sail Advisors, the Hong Kong-based $2.2 billion AUM fund of hedge funds specialist.

“Now that we are seeing a lot more volatility, it will become more apparent which hedge funds and fund of funds have been able to properly manage their net exposure and liquidity,” Sjostrom said.

That will enable investors to better assess gains from illiquidity risk taken by managers.

Sail Advisors has been overweight liquid strategies in Asia – and long/short equity in particular – over the last couple of years, said Sjostrom.

UBS’s $32.3 billion AUM fund of hedge funds business is “strongly positive on Asian long/short equity” followed by the US and lastly Europe, due to ongoing concerns about Greece, said Raffaldini. He observed that there is a “lot of alpha” to be extracted from Japan’s equity markets in particular.

Asia ex-Japan has seen the strongest rise among Eurekahedge’s regional indices – rising 9.87% year-to-date to the end of July. Long/short equity is the strongest performer among the data provider’s strategy indices, rising 5.98% year-to-date.

“We favour catalytic strategies focused primarily on event driven equity and activist equity strategies,” said Ray Nolte, New York-based CIO of SkyBridge Capital, the $13.4 billion AUM fund of hedge funds.

“We have recently begun to migrate some of our exposure to European events,” Nolte added, explaining that the manager has been primarily focused on the US to date. “We anticipate allocating additional capital to Europe [this year and next]”.

Both Raffaldini and Nolte highlighted structured credit – such as residential mortgage-backed securities  – while urging a cautious approach to other credit strategies. “We have little to no corporate credit within our portfolios,” said Nolte. Raffaldini added that it was “still too early in the cycle” for distressed debt.

Nolte is also cautious about macro strategies. “We believe that it is still premature to add significant capital to the sector,” he said.

UBS Hedge Fund Solutions “prefers macro over CTA,” said Raffaldini, favouring discretionary over systematic macro managers.

Strong equity market rises have seen trend-following CTAs go long equity with the result that “the source of non-correlation is not there,” explained Raffaldini. In contrast, discretionary macro traders are more focused on interest rates and foreign exchange, which Raffaldini believes will continue to provide non-correlated returns.

Furthermore, the “uncertain background for interest rates makes arbitrage interesting,” added Raffaldini. He continues to see opportunities for arbitrage and relative value strategies as hedge funds fill the void left by banks in the wake of the US Volcker rule.

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