Active-management alpha now key to hedge funds’ success, as economies emerge from Covid slump

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K2 Advisors, the hedge fund investing unit of Franklin Templeton, says active-management alpha will be critical to hedge funds’ success this year, as the global economy mounts a tentative recovery from the coronavirus pandemic.

Brooks Ritchey and Robert Christian, co-heads of investment research and management at K2, said the Covid-driven economic slowdown appears to be nearing an end, as individuals and corporations have been able to weather the economic storm partly due to “enormous stimulus” from governments.

But they warned that vaccination challenges, virus mutations, subsequent waves of new infections, and renewed lockdowns could derail the recovery.

That, in turn, could keep volatility and dispersion elevated, creating opportunities for active management.

K2 Advisors’ first-quarter Q1 hedge fund strategy outlook suggested inflation “will inevitably surface” if earnings, growth and sentiment jump the gun on the recovery, though a period of reflation without inflation could boost equities.

“Our underlying hedge fund managers are identifying many opportunities, both on the long and short side, and think that active-management alpha will be key to success in 2021 as beta-driven momentum slows,” the pair observed in the commentary.

“As a result, we believe it is prudent to be growth-oriented in our portfolio positioning while also holding hedged alternative investments that exhibit low correlations to broader risk assets.”

Turning to specific strategies, K2 suggested that international long/short hedge fund strategies are “poised to outperform” this year, with non-US developed markets, as well as emerging markets, strengthening as economies emerge from the virus.

“Non-US equity markets could be further buoyed by their natural bias towards cyclical and value-type names in contrast to US market reliance on the overstretched technology sector and growth companies more broadly,” it noted.

K2 – which provides a range of hedge fund and alternative investment products including single investor custom-tailored investment programs, commingled funds of hedge funds, and strategic advisory structures across multiple strategies – said long/short credit managers, as well as EM-focused macro strategies, could also benefit from the prevailing market backdrop.

“Dispersion in credit markets coupled with the need for yield should also provide a good opportunity for long/short credit managers and dispersion trading as many industries and companies are disparately dependent on a speedy recovery,” Ritchey and Christian said.

“We expect that the bigger, stronger companies will be very active in strategic business dealings to further strengthen their advantages over weaker competitors.”

The note also observed how structural trends built around e-commerce, deglobalisation of supply chains, healthcare, security, software and sustainability have accelerated as a result of coronavirus.

Emerging markets may benefit from a confluence of rebounding growth, sustained policy support, and improving fund flow dynamics, K2 added.

“Macro specialists focused on emerging markets may benefit from these tailwinds as well as wider dispersion in country and asset-class performance in the wake of the last year’s crises and divergent policy responses.”

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Hugh Leask
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