Macro hedge fund Arete Capital eyes shorter duration assets amid rate rise shift

Asia from Space

Global macro hedge fund Arete Capital Partners is tilting towards shorter-duration assets amid an evolving rate environment which carries far-reaching consequences for inflation and the cost of capital.

The Arete Macro Fund – a China- and Asia-focused global macro hedge fund strategy – trades a spectrum of liquid assets including equities, fixed income and commodities. Established in 2012, it is one of nine hedge fund strategies that make up the Brummer Multi-Strategy fund, run by Stockholm-based Brummer & Partners.

In a recent market commentary, Li noted the current “disconnect” between the market and the US Federal Reserve, which has seen the market pricing in as many as four rate rises between now and the end of 2023, while the Fed’s targeted stance suggests a more reactive approach to hikes.

Will Li, founder and CEO of Hong Kong-based Arete, said the firm has rebalanced its portfolio away from long-duration assets – such as fast-growing, high valuation companies – towards shorter-duration, cheaper companies with good profitability.

“We take long-term positions through macro frameworks, combined with shorter-term catalysts which take the supply and demand situation into consideration,” Li explained, adding value and cyclicals might benefit from the current inflationary environment. “Idiosyncratic factors for each position are also key.”

The Arete fund is positioned on the front-end on the assumption that the Fed’s plan is closer to what may play out, while the back-end of the curve is fueled by inflation expectations and term premium, which is turn driven by volatility.

“With the front-end really anchored by the Fed there is a chance that the back-end volatility will increase and therefor increase the term premium,” Li explained. “Increasing risk, including term premium, and increasing inflation expectations may lead to a further steepening of the yield curve. So our current view is that we’re still seeing more curve steepening on the US dollar rates.”

The Fed sticking to its average inflation targeting regime will likely result in inflation rising slightly, said Li, which would in turn lead to the government’s income rising faster than its obligations on debt services.

“If government income can grow faster thanks to higher inflation, that can be a path for resolving the debt burden,” he explained, while acknowledging the transition out of the current regime remains “a very delicate process.”

The potential negative impact on the economy and markets from the Fed tapering its quantitative easing programme, or a rate hike aimed at normalising the situation remains “one of the key worries,” Li added.

After four decades of declining costs of capital, an “inflection point” may be imminent, leading to an upward trend in capital costs, which would weigh on longer-duration growth stocks. But he stressed that, in addition to interest rates, volatility and inflation expectations should also be taken into account.

Though rising costs of capital is a longer-term trend, shorter term catalysts also inform Arete’s position-picking process across different asset classes and markets.

“The most direct way to play this is through a US dollar rate steepener, a position we’ve had since last October,” he said. “And we still think there is more room for the curve to steepen.”