Alpha

2014 could see alpha and dispersion rise in importance over beta, says GAM’s Lawler

Hedge funds had a strong final quarter of 2013 and ended the year up 6.7 per cent, as measured by the HFRX Global Hedge Fund index returns in US dollar terms.

“The four main hedge fund strategies all performed positively over the final quarter and we believe this momentum is likely to continue into 2014, although we must be aware of dark spots on the horizon,” says Anthony Lawler, portfolio manager in GAM's alternative investments solutions team.
 
“In 2013 the trade that was most beneficial was to be long developed market equities. The investment outlook for 2014 looks far less straightforward, given current elevated equity valuations and other global risks.  The outcome for this year could be contingent on three key factors,” says Lawler. “First, the economic recovery becoming self-sustaining in development markets. Second, the normalisation of US monetary policy. And last, structural and policy reform in several important markets, with issues such as fragmentation in Europe’s banking system, Abenomics in Japan, and the success of China’s Third Plenum.”
 
The question is how these three key factors will influence the performance of hedge funds in 2014, says Lawler.
 
These issues raise the likelihood that markets will not rise nor fall all together and as such, simple beta exposure may not be the optimal trade for the year, but rather this could be an investment environment characterised by regional and asset class differentiation.  This would be a positive environment for active management, alpha generation and dispersion.
 
Given the many uncertainties and possible market potholes ahead, GAM continue to favour managers across all strategies that have proven nimble and active, enabling them to better navigate through market volatility.
 
In 2013 equity long/short strategies were well supported with the HFRX Equity Hedge index up 11.1 per cent in US dollar terms.
 
For 2014 Lawler says: “Considering the risks and current valuations, equities are unlikely to offer a continuing fast rising tide for all boats, but rather it could be more about industry, country and company fundamentals and especially earnings growth. This global outlook with expected dispersion of paths provides an attractive environment for fundamental long / short stock-pickers.”
 
Overall 2013 was a strong year, particularly for equity special-situation investments. The HFRX Event-Driven index was up 13.9 per cent in US dollar terms and the outlook remains positive into 2014.  Many of the themes that benefited event driven funds in 2013 are expected to remain in place (high cash levels, activism, share buybacks, spin-offs, etc.) and GAM anticipates M&A to finally accelerate as corporations shift their focus from cost cutting to growth plans.
 
In aggregate, 2013 proved a challenging year with the HFRX Macro/CTA index closing down 1.8 per cent in US dollar terms. While several equity markets staged significant rallies, other asset classes were more difficult with significant policy surprises and market reversals during the year. As a result, global macro broadly under performed as many managers in the space do not trade heavily in equities but rather often focus on fixed income and currencies, which proved more challenging.
 
Looking to 2014, Lawler says: “We see improving macro opportunities but with continued risk from policy surprises. Managers remain bullish on the Japan theme – long equities, short the yen and short Japanese bonds.  Globally, currencies and fixed income have become more interesting given the differing paths of regional growth and the FOMC versus the ECB and versus other central banks. As such, we expect to see stronger returns in currencies and rates trading. All in all, should we see higher-than-expected global growth and/or dispersion across regions, it could set the stage for some notable moves creating opportunities for discretionary and systematic managers alike.”
 
Relative value and credit: 2013 was a good year to be positioned long in higher yielding credit whether in the form of corporate credit or structured credit as the global ‘reach for yield’ continued. For the year, the HFRX Relative Value Arbitrage index was up 3.0 per cent in US dollars as short positions cost managers given the broad rally in credit.
 
GAM expects 2014 to be more of an alpha-driven market, says Lawler: “Although banks are forecasting a benign default outlook for 2014, credit spreads are near all-time tights and there are early warning signs of frothiness while separately there is the potential for central banks to begin reducing liquidity. Given this, our base case is that buyers will be more selective and not simply buy all higher yielding instruments, and we could in some cases see spread widening.”
 
At a strategy level, GAM is positive on the outlook for event driven and equity long/short as was the case throughout 2013.
 
“We expect these strategies to continue their strong form, but we are not simply leaning long risk assets, but rather looking for managers that are by and large hedged, nimble and can quickly change their books if they see a breakdown in growth or policy effectiveness or structural reforms,” says Lawler. 
 
Within relative value, GAM remains positive on certain credit exposures.  Finally, for global macro and CTA managers, GAM favours specific managers who have shown an ability to produce results regardless of market direction and with real interest rates pegged near zero.

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