As alpha becomes increasingly limited, institutional investors are allocating more to alternatives and hedge funds and having to deal with increasing competition for managers, experts from the likes of GIC, Investcorp and Pimco discussed during a panel on the first day of the Milken Institute Asia Summit 2021 yesterday (November 15).
“If we think about the evolution of hedge funds, the big story has been that the overall average returns have come down. And maybe it's not surprising given that there's been more money over the last couple of decades that have gone into hedge funds, and more managers have gone in,” Jeffrey Jaensubhakij, group chief investment officer at GIC said during a panel discussion at the event in Singapore.
He added that beta returns are still available especially in fixed income, “and with the high valuations, what is available in equities is significantly lower than they have been in the past.”
The current environment allows investors to shape their portfolio, he explained. “For us, for example, we're not aiming for a portfolio that that has had the highest returns competing with equity year-on-year, but rather one that can have a good return, but good downside protection,” he said.
“And that downside protection can have a lot of use when other assets are selling off. So I think there's still room for asset owners to put hedge funds into their portfolio,” he said.
Sovereign wealth funds have been increasing allocations to hedge funds, according to GlobalSWF estimates, despite hedge fund performance falling each quarter in the past 12 months. According to the equal-weighted Eurekahedge Hedge Fund Index, performance has fallen from 8.52% in the fourth quarter of last year to -0.22% in the third quarter of this year.
As always, diversification is key to any portfolio, Jaensubhakij said, even as competition for managers has risen.
“There are some managers who, because of their skill, they can afford to pay better and hire better managers, but also have a culture that tends to drive better performance, better risk management - I think if you can find those, and then try to keep capacity available with those managers, there is a chance to create that portfolio of managers that you'd like,” he said.
“But unfortunately, with the markets being so topsy turvy in many ways, there's also been quick rotation in styles. And without proper diversification, you could end up being fairly whipsawed as well. So I think, for us, really that portfolio construction of which funds you pick, how you put them together is very key to being able to stay invested, if you will, in the hedge fund universe,” he added.
John Studzinski, vice-chair at Pimco, said at the same panel that the firm has observed more dislocations in the market, leading them to identify dislocation windows which will “put funds to use for 12-18 months and producing 15-20% returns on those funds,” he said.
“But you've got to be in the market present, focusing on the geography, the industry, whether it's aviation, specialty finance, or certain types of real estate, even in Asia, looking at it very specifically for dislocations,” he said.
He added that funds must have strong credit in order to take advantage of those opportunities. “And you're going to see more people move into alternatives during these next five years, where you're going to have a much more volatile market. And the biggest growth areas of a number of companies is going to be in retail, targeted at the alternative space,” he said.
Taking cue from his experience in the post-financial crisis restructuring of insurer AIG, Studzinski warned that unlike then, the global environment today is not in lockstep and there was little international collaboration in dealing with the pandemic.
the event in hologram form
“For the next crisis, including in the financial space, I worry that there isn't going to be enough international collaboration,” he said.
The investment world is only getting more complicated as investors face uncertainties with inflation and interest rates.
In a separate session at the event, Steven Mnuchin, former US Treasury secretary, who appeared on stage in a holographic form from the US, said that he believed the Federal Reserve is doing the right thing of tapering the portfolio.
“It is something they need to do to normalise interest rates. It’s just a question of how quickly they do that,” he said. “I think the Fed needs to do it both in a way that combats inflation in a way that doesn't overly disrupt the markets. And I think they've started that process.”
Pointing out that the Fed could not get to its target of 2% inflation before Covid, he thinks that “we're going to probably end up with 3-3.5% inflation, and 3-3.5% 10 year Treasuries”.