Hedge fund indices will lose their support in H2 (macro themes, better dispersion in stock returns) after a strong H1.
Reduce exposure to Market Neutral strategies.
Prefer managers using in-depth fundamental analysis, especially in the US, and Long & Variable Bias funds in Europe.
Little opportunity for Credit managers because of low rates and tight spreads.
Prefer Global Macro to Commodity Trading Advisors (CTAs) and Special Situations to Merger Arbitrage in H2.
Concentration kills performance
"The concentration of positions in the same sectors and stocks means that Long/Short Equity managers might now struggle to perform."
Long/Short Equity. We have witnessed sizeable inflows into factor-based exchange-traded funds and a growing use of quantitative models based on the same factors by hedge funds. The resulting concentration of positions in the same sectors and stocks means that many managers might now struggle to perform after a period of gains. In addition, the continued flows into passive index funds suggest a tougher environment for managers’ short positions, in a context of generally extended valuations.
We would reduce exposure to Market Neutral strategies, where risk is building on both long and short exposures. Our preference would be for managers using in-depth fundamental analysis, especially in the US, and for Long and Variable Bias funds in Europe.
Event Driven. Special Situations managers have locked in profits on around one-third of their positions, refocusing on mid/small capitalisations and Europe. This shake-up is due both to fading hopes of fiscal stimulus and a shift towards cheaper, less-crowded trades. In addition, funds’ sensitivity to market trends – aka “beta” – is relatively high at 50%, which is helpful as long as the uptrend holds.
Despite rising business confidence, merger and acquisition volumes have fallen back, meaning that capital in Merger Arbitrage is chasing a reduced opportunity set with tighter spreads between the prices of predators and their prey. However, most deals are completing successfully, which has helped managers to capture decent carry. Stay neutral.
"The opportunities available for Distressed Debt funds should remain thin on the ground."
Credit / Distressed Debt. As explained on page 8, credit spreads have been squeezed ever tighter by central bank purchases and investors’ thirst for yield. This creates a conundrum for Credit Arbitrage managers, with fewer mispricings to exploit. In addition, steady flows into passive bond funds mean that correlations have risen. Opportunities persist in certain niches such as subordinated financials.
The supportive backdrop and wide availability of credit to weak borrowers mean that default rates are unlikely to spike in coming months – the opportunities available for Distressed Debt funds should remain thin on the ground. One area which might yield some openings is Energy if oil slumps further than we expect (page 16).
Global Macro / CTAs. Strong equity market trends led to a concentration of exposure there for CTAs. This eliminates one of the key benefits of CTAs, traditionally a good hedge against market downswings. In addition, many markets have become rangebound, making conditions more challenging for trendfollowers. In this light, investors should avoid CTAs.
The recent dollar weakness and the rally in government bond prices have led Global Macro managers to abandon their previous concentration on Long Dollar, Short Sovereigns positions. This rebalancing has diversified the themes and markets within portfolios. Two areas of particular opportunity are divergences in rates and multi-asset positions in emerging markets.
Sources: SG Private Banking, Bloomberg (06/07/2017). Past performance should not be seen as an indication of future performance. Investments may be subject to market fluctuations, and the price and value of investments and the income derived from them can go down as well as up. Your capital may be at risk and you may not get back the amount you invest.