K2 Advisors flags up fresh opportunities for hedge funds, as economies emerge from coronavirus carnage

Opportunity

Pricing dislocations across a broad range of industries and geographies, coupled with an increasingly fragmented macroeconomic landscape stemming from divergent emergency central bank measures, will throw up a wealth of investment opportunities for macro, equity and credit hedge fund strategies in the second half of 2020, K2 Advisors, the global fund advisory unit of Franklin Templeton, has said.

The firm’s third quarter hedge fund strategy outlook pointed to potential economic tailwinds stemming from increased consumer spending post-lockdown, a weakening US dollar, and higher commodity prices.

“In this environment, one might expect the US yield curve to steepen, non-US equities to outperform domestic equities, and the dispersion of credit instrument returns to widen,” Brooks Ritchey, senior managing director and head of portfolio construction, and Robert Christian senior managing director and head of investment research, said in the note.

“We believe such a scenario would likely benefit long/short equity, macro/CTA, and long/short credit managers.”

Looking ahead, volatility is set to remain elevated as a result of geopolitical uncertainties and a slower economic recovery cycle. 

Specifically, Ritchey and Christian pointed to recent protests in the US, Europe, and Hong Kong as indicative of frustrations felt by populations around the world during this year’s economic and social upheaval. Meanwhile, the outcome of November’s US presidential remains uncertain, potentially contributing further to market volatility.

Food and package delivery services, online retailers, and home-based hardware and software technology companies are tipped to thrive in the post-lockdown environment. On the flip-side, airlines, commercial real estate and on-site entertainment sectors such as theatres, casinos and concert arenas will face a continued squeeze.

Against that backdrop, hedge funds can zero in on a raft of investment opportunities and themes arising across different markets and industries, according to Ritchey and Christian.

Discretionary macro hedge funds can capitalise on the “extraordinary” policy measures aimed at tackling the health and economic crises arising from the coronavirus pandemic, they said in the note.

Specifically, K2 identified potential relative value opportunities in certain macro asset classes like currencies, driven by disparate policies and wide dispersion in economic conditions between countries before and after the policy implementation.

As Covid-19 has created economic uncertainty across economies, the future recovery is unlikely to take a “one-size-fits-all” trajectory, they added. Share price dispersion both within and across sectors is likely to accelerate positive and negative long-term trends, providing rich trade ideas for long/short equity hedge funds.

Meanwhile, long/short credit managers can expect to tap new opportunities arising from thawing credit markets, which have seen a flurry of new issuance after the US Federal Reserve took emergency steps to kick-start markets which seized up amid March’s historic volatility.

“First, managers can buy bonds directly from the company and sell them into the secondary market, often at a premium,” K2 observed.

“Second, a flurry of activity often means the market is less discerning at the individual-deal level. Managers can apply a relative value approach, initiating a long position in one company against a short position in another company in the same industry, effectively isolating risk in the trade to the individual issuer.”