HSBC Private Bank is maintaining its highest conviction overweight in hedge funds in the belief that the active and flexible investment approach employed by hedge funds is well suited to the current volatile market conditions.

In the latest HSBC Private Bank Quarterly Investment Outlook, Willem Sels, UK Head of Investment Strategy at HSBC Private Bank says: “With the recent slowdown in growth combined with high inflation being a challenge to riskier assets, we have downgraded equities, commodities and high yield bonds to neutral. With the upside in traditional asset classes becoming more limited, and markets likely to be volatile, we believe that hedge fund managers should perform well.  Accordingly, hedge funds remain our highest conviction overweight and they should continue to help limit portfolio volatility whilst also being well placed to take advantage of this volatility.  Historically hedge funds have also been less sensitive to an economic downturn than equity indices.

Commenting on the outlook for the various hedge fund strategies and increased Asian allocation, Tim Gascoigne (pictured), Global Head of Portfolio Management at HSBC Alternative Investments Limited says: “Hedge funds have had encouraging returns since the start of 2011, and we believe that the current environment should continue to provide attractive opportunities to managers. This year, the strongest returns have come from macro strategies, as global shock events and ongoing geopolitical concerns continue to influence investor sentiment. We expect this trend to continue in the coming quarters.  In contrast, the futures-focused systematic strategies have given back performance over the past two months as we have witnessed major reversals in currencies and commodities over this period.  We believe that volatility in these markets is likely to persist, which could weigh on this strategy’s return potential in the coming months.
 
“We continue to see attractive opportunities in the equity long/short space. The clear mismatch between higher and lower quality stocks caused by the unusually high correlation in 2010 – when markets focused on macro views rather than company fundamentals – has created an excellent opportunity set for managers, in our view. To this effect, equity market neutral strategies have had positive performances, continuing their strong run with supportive fundamental factors, helped by falling stock correlations.
 
“M&A activity has picked up this year and, with strong corporate balance sheets, this trend looks likely to continue. However, deal spreads are starting to look tight and often require uncomfortably high levels of leverage to extract meaningful returns. As a result, we prefer the event-driven arena where catalysts such as share buy-backs, restructurings and spin-offs are providing better risk-adjusted returns in our view.
 
“Looking forward, we believe that distressed market strategies may become more attractive thanks to a second wave of defaults in mid-market companies financed solely through bank loans, and thus hidden from the headline default rates. European banks have yet to shed their higher risk-weighted assets and, if the advents of Basel III catalyses this, we believe it could lead to a broad opportunity set for some managers.
 
“We are also looking at hedge fund strategies that can take advantage of the broadening opportunity set across emerging markets, which we believe should prove attractive returns. Indeed, we are increasing our Asian exposure, reflecting the deepening pool of talent and in that region and our continued focus on the emerging markets.
 
“Within our flagship USD2.5bn HSBC GH Fund we have increased our Asian exposure to 15% from 10% having most recently allocated to two of Asia’s largest hedge funds – Azentus Capital and Ortus Capital.”