“Fruitful” opportunities ahead for macro hedge funds, but credit strategies face Q2 challenges

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Discretionary macro hedge funds can expect a “fruitful opportunity set” over the next three months thanks to continued market unpredictability, but falling default rates have soured the Q2 outlook for distressed credit strategies, according to Man FRM’s quarterly hedge fund outlook.

The second quarter outlook is “generally positive” for hedge funds, said Jens Foehrenbach, managing director, Man Solutions.

Man Group’s hedge fund investing unit FRM has taken a positive stance on event driven strategies, especially merger arbitrage managers, which are now well-placed to tap into the rising levels of deal activity, wider spreads, and a competitive M&A environment.

At the same time, discretionary macro hedge funds can expect a “fruitful opportunity set” over the next three months, fueled mainly by continued volatility across asset classes, and a divergence in the speed of economic recovery between countries and regions.

The varying pace of recoveries is also set to benefit long/short equity hedge funds, Foehrenbach said, especially those managers that exhibit factor awareness. He added that the GameStop saga has made equity managers much more cognisant of the risks around short squeezes and position sizing.

“If we continue to see signs of recovery and inflation surprises on the upside, as we expect, Value optimism should grow as expectations for rate rises are priced into longer-term rates, as we’ve seen historically, and a Growth/Momentum decoupling is possible,” he noted. “In this environment, managers who display factor awareness should be able to seize on the opportunities such rotations can generate.”

Elsewhere, there is renewed enthusiasm for emerging themes in quantitative strategies, namely in China, systematic credit, and ESG.

But in credit, Man FRM has shifted its stance on long/short strategies to neutral, and negative for distressed funds - a notable switch following a positive outlook over the past four quarters. 

“The opportunity set for credit long-short managers is now more idiosyncratic with less room for meaningful price appreciation and spread tightening on a market-wide basis,” Foehrenbach explained.

“Managers continue to focus on intra-capital structure dislocations, particularly debt versus equity and liability management-related trades in sectors that have been directly impacted by Covid-19. We find the risk/reward for taking a lot of outright credit risk unfavourable.”

While distressed managers have capitalised on the pipeline of opportunities created by the spike in defaults during 2020 – which rose to USD141.4 billion overall last year – recent months have seen a “substantial decline” in defaults, with only USD2.1 billion of activity so far in 2021.

“In the near term, there might still be opportunities for distressed managers to be liquidity providers to certain companies in what might be fundamentally challenged sectors,” he added, pointing to the energy, retail, travel, leisure, and gaming industries.

“But capital deployment for these managers will become more challenging given the easy financial conditions. Hence, we have shifted our outlook for the strategy.”

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Hugh Leask
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