Global stock prices and volatility are likely to rise this year, presenting an attractive environment for certain hedge fund strategies, argues Andrew Lee, deputy global head of ultra-high-net-worth and alternative investments at UBS Wealth Management. He is not alone in his prognosis.
The Swiss bank has kept its broad allocation to hedge funds the same this year as in 2015, in the 14-18% range, having raised it a little at the end of 2014. It recommends an allocation of up 40% to private markets for clients who can tolerate illiquidity.
From a risk-adjusted return perspective, hedge funds are attractive relative to both equities and bonds, Lee noted, particularly compared with high-grade bonds (those rated AA and above), given their “extraordinarily low” yields. “UBS’s recent increase in hedge fund exposure was funded from high-grade bonds,” he said.
In terms of specific strategies, Lee likes equity long/short, but not the directional component. “We want approaches with more alpha generation and emphasis on the short side – those which are more focused on stock-picking and not so much on beta.”
The environment is also becoming more attractive for macro strategies, said Lee, as continued divergence in central bank activity creates opportunities in currencies and rates. Again, he favours relative-value plays in this space rather than highly directional strategies.
Others hold similar views. Mike Imam, managing partner at Hong Kong multi-family office Silverhorn Investment Advisors, has reduced his firm’s directional equity exposure. “We don’t see directional momentum we can capture in developed markets like Europe and the US,” he noted.
Imam said he preferred market-neutral hedge managers or skilled stock-pickers, which by design have less beta exposure.
Likewise, William Ma, CIO of Chinese wealth manager Noah Holdings, last month explained his reasoning for backing long/short for the coming months and why he recommends moving back into Asian equities again.
Like UBS's Lee, Silverhorn also favours large global multi-strategy managers given their ability to create returns across different strategies and asset classes – or mixing strategies and managers to create market-neutral exposure. "It’s very difficult to have a lot of conviction now, because views are all over the place,” said Imam.
Damien Tan, hedge fund specialist at investment consultancy Cambridge Associates in Singapore, is also bullish on global macro strategies. "If bear markets and crisis-type situations occur, then systematic trend-following funds could do well, especially those with shorter time horizons," he said. "They did well in bear markets in 2008."
"You need managers that are diversified enough across different asset classes and securities -- i.e. funds that are not too big so that they can also participate meaningfully in markets with lower trading volumes," he added.
However, Mike Levin, head of asset management for non-Japan Asia at Credit Suisse, argues that event-driven will be the best performing hedge fund strategy in 2016 because of "continued strength in deal activity, wider spreads, a lack of risk capital relative to deal sizes and a sell-off in crowded special-situation deals in 2015".
Levin would be wary of leveraged strategies in fixed-income arbitrage. While there will be opportunities created by market dislocations, he said, high levels of volatility and variable liquidity will pose challenges for geared players, which may get caught "flat-footed".
Going by net inflows in the fourth quarter of 2015, investors appear to agree on the prospects for macro and equity hedge strategies, according to data provider Hedge Fund Research.
Macro and CTA hedge funds led strategy inflows for the quarter, receiving $2.5 billion in new capital for the quarter, bringing macro to a narrow inflow of $900 million for 2015 and total invested in the strategy to $550 billion. Macro sub-strategy flows were led by quantitative, trend-following systematic diversified CTA funds, with $1.7 billion of inflows in Q4.
Equity hedge led capital inflows for last year, receiving $25.8 billion, including $2 billion in Q4, bringing total invested in these strategies to $829 billion, the largest concentration of capital by strategy.
It will be hoped that 2016 performance will be better than last year, when the HFRI Macro (Total) Index fell -1.15% and the HFRI Equity Hedge Index lost -0.8%.
Meanwhile, event-driven suffered outflows of $2.2 billion last quarter but saw 2015 net inflow of $8.7 billion, with total assets rising to $745 billion. Relative-value arbitrage experienced outflows of $3.8 billion in Q4, bringing 2015 inflows to $8.4 billion.