Investors have been shaken out of their collective comfort zone and forced to look for alternative sources of yield as the conventional 60/40 portfolio model is challenged and market returns in traditional asset classes dwindle. Opportunity persists in the volatility, macro and CTA spaces but investors can expect to begin paying more for pure alpha.
Investors have been shaken out of their collective comfort zone and forced to look for alternative sources of yield as the conventional 60/40 portfolio model is challenged and market returns in traditional asset classes dwindle. Opportunity persists in the volatility, macro and CTA spaces but investors can expect to begin paying more for pure alpha.
Managers have reported growing enthusiasm for uncorrelated strategies, as going long the market becomes less and less attractive. Gary Selz (pictured), CIO, Zero Delta Funds, says:
“For the longest time investors said, ‘why would I invest in something possibly more complicated if I can just stay long the market?’ That sentiment has shifted a bit, driven by higher interest rates and markets becoming more volatile. Now that the Vix is not in that 15 range anymore, it’s more in the mid-20s range, it has changed a lot of investors’ appetites for alternative strategies.”
Alongside other experts, Selz will be discussing investor attitudes to hedge funds in greater depth as a panellist at the Amsterdam Investor Forum (AIF). Organised by ABN AMRO, the event will take place on 21 September, 2022.
Susanna Wallis (pictured), senior investment manager at Union Bancaire Privée and fellow AIF panellist, and Kier Boley, CIO of Alternative Investment Solutions at UBP, also identify investors’ increased need for alternative sources of return. “We see investors seeking to find replacements for some parts of their portfolio. They might be looking for an equity or fixed income replacement; they may also be looking for a diversifier – something that’s quite uncorrelated with broader markets,” Wallis notes.
In the hedge fund space, she sees enduring opportunity in Macro and CTA strategies, where the industry has already registered strong inflows: “Part of the appeal is performance driven as these strategies have done extremely well, year to date, but the interest is also more strategic.
“The opportunity set for these strategies is quite good as you’re seeing higher volatility in the markets and higher front-end rates which is very helpful for these strategies. As central bank policy is more determined by fundamentals, this breeds a very good environment for both systematic and discretionary macro strategies to do well.”
UBP is due to host a roundtable discussion at this year’s AIF, outlining investor trends.
Discussing the outlook for volatility strategies, Selz, whose firm Zero Delta Funds specialises in this space, expects significant opportunity as investors hunt for yield in a market where the outlook for many traditional asset classes is relatively bleak. He outlines:
“There are many investors still trading options for speculation or looking for yield. There are also different types of market participants and more have been entering the market recently; retail trading has been on the rise the past couple of years. Further, with large institutions like Softbank getting involved in the options market, there have been plenty of opportunities to take advantage of dislocations in the options markets and we think that will continue.”
Desire for uncorrelated assets
Although investors have sharpened their desire for uncorrelated, potentially higher returning hedge fund strategies, their ultimate success in this venture will depend on the way they build their portfolio.
Selz explains it is vital for investors to construct portfolios they are comfortable with, especially in the volatility arena: “Typically, investors often focus on the volatility managers who have blown up. They think volatility is either just selling vol premium or conversely, buying vol premium. There is a middle ground of relative value volatility strategies that may provide a different risk/reward profile that might fit within their portfolios.” He stresses that understanding is critical when investing: “If you don’t understand the strategies, then you probably shouldn’t be in them. I’d warn investors to not get lured in by amazing returns, but to really spend time researching and trying to understand the strategy. It will make them better investors in the long term.”
In Wallis’s opinion, one of the main things investors should focus on is suitable liquidity: “Liquidity of underling assets should match the fund’s investment objectives and be in line with the fund’s own dealing terms. In these markets, as central banks withdraw liquidity, some market will experience sharp falls in turnover volume”.
This is likely to be one of the main challenges for the industry whilst central banks remain hawkish on inflation.
However, beyond investment risk, Selz believes the primary obstacles investors face at present are operational: “The things that keep me up at night are not related to investing and strategy. There will always be strategy drift and you need to work to make sure that doesn’t happen; but losing money due to the strategy or market conditions is just part of investing.
“Losing money on back office or execution errors is something that could really blow up your business and bring your investment down to zero. That is what keeps us up at night more than anything.”
Selz outlines the critical nature of prime brokerage and other back-office functions, noting this has become a difficult space to navigate: “Many banks have been getting out of prime brokerage so finding the correct provider that understands the risk of all the trades and prices accordingly is a challenge.”
Rising cost
On an industry dimension, Boley outlines that the move into higher yielding alternatives means investors can expect to face the psychological struggle of having to pay their managers more.
He says: “Over the course of the recent past, investors have been very focused on expense ratios and total costs. In traditional assets, they have been able to lower their management fee and their total expense ratios by doing more and more indexing via products.
“If you are now having to switch to more active managers both in the long only space as well as within the hedge funds, which is the purest active management, your total expense ratio is going to start creeping back up, just because they are more expensive structures.”
Whether there will be a longer-term shift to higher costs across the board depends on the particular strategy being discussed. Within capacity constrained vehicles for example, it is difficult to negotiate lower fees, so investors need to be prepared to pay for performance.
Readers can learn more from these experts and other luminaries in the field of alternative investments at the 2022 AIF to be held later this month.
For more information and to register please visit: https://www.amsterdaminvestorforum.com/
