A vote of confidence
- Three in five investors plan to increase or maintain their hedge fund exposure
- Macro is the favoured strategy (32%), followed by fixed income/credit (28%)
- Interest from most investor types is solid, albeit with churn from private wealth
By Hugh Leask
Investors' allocation plans for 2023 reveal a surprisingly strong vote of confidence in hedge funds' ability to enhance portfolio returns amid continued equity and bond market volatility and macroeconomic upheaval.
Roughly a quarter of all allocators spanning institutional, private and FoF capital (23%) want to pour more money into hedge funds next year, with a further third (35%) set to maintain their existing allocations. In contrast, just 13% intend say they will withdraw money from the sector next year.
That said, overall interest in hedge funds, while solid, continues to be outflanked by appetite for other alternatives such as private equity, private credit, and real estate.
Industry practitioners cite this year's considerable dispersion in hedge fund performance, and the perception of private assets as better insulated from wider shocks, as the reasons for the lag. eVestment fund flow data meanwhile suggests investors have now pulled more than $63 billion in the period to the end of Q3, with only managed futures and multi-strategy funds attracting meaningful inflows this year.
"Hedge fund strategies with a low beta to risk assets are of natural interest following the period of rotation we're coming through into 2023," says Travis Williamson, partner and head of hedge fund research at Albourne Partners, noting that global macro, as well as CTAs – which have notched up gains on average of nearly 20% YTD – offer the potential for continued success during periods of economic transition.
Having surged more than 11% in the 10 months since the start of this year, macro hedge funds – which trade broader macroeconomic and geopolitical trends using equities, bonds, commodities, currencies and more on a discretionary and systematic basis – are unsurprisingly the frontrunner, with almost one-third of all investors (32%) preparing to up their allocations.
Elsewhere, 21% of investors plan to up their exposure to multi-strategy managers which offer diversified returns. And despite 2022's stock market turmoil – which has left equity long/short hedge funds nursing losses in excess of 11% more than 1 in 5 investors are still keen to grow their allocations in what remains the industry's largest and best-known strategy type.
"Macro is the big focus – there is huge demand for macro right now, as people see it as being the primary beneficiary of the higher rate environment, observes Richard Byworth, managing partner and head of liquid alternatives at Syz Capital." Either investors are having a specific conversation about macro, or they want macro as part of a multi-strategy allocation. In our portfolio breakdown, it is the macro firms that are seeing the largest outperformance, and so that makes sense for people chasing returns. With the Fed now suggesting higher rates for longer, it is logical that these strategies are of continued focus."
Beyond the headline-grabbing gains in macro and CTAs, the rising rate backdrop also offers catalysts for opportunities in certain fixed income arbitrage and credit hedge fund strategies next year, market participants say. That view chimes with Hedgeweek data showing that 28% of all allocators intend to pour more money to fixed income/credit strategies – second only to macro funds – with a further 28% maintaining their allocations here.
"Fixed income long/short is an alpha opportunity," says Brooks Ritchey, senior managing director, co-chief investment officer, and portfolio manager at K2 Advisors, which runs about $12 billion focusing exclusively on hedge fund strategies, funds of hedge funds, and funds of separately managed account products for institutions and private investors.
Outlining the arbitrage trade, he notes how interest rate hikes will continue to widen the gap between strong and weaker companies. "Those that don't need a lot of financing have large cash holdings – and they should do well going forward as they don't have to pay the higher interest rates. Those groups that do require financing should see profit margins reduced because of higher borrowing costs."
Managers trading corporate and high-yield fixed income securities long and short, including relative value arbitrage strategies, are well-placed to deliver performance and diversification over the coming 12-15 months, he adds.
"Later, probably by early summer 2023, the fixed income long/short managers and relative value managers will see central bank policies clarified, so they will get a performance tailwind from the bond market stabilising and potentially rallying."
Elsewhere in the credit space, new research published by BNP Paribas Prime Services shows investors are preparing to pile into a range of credit hedge fund strategies, especially in the more illiquid end of the spectrum, as rate rises and a deteriorating global economy expands the distressed credit universe.
Marlin Naidoo, global head of capital introduction and consulting at BNP Paribas, says: "While private credit continues to be of interest, it's not increasing. Instead, what we are seeing is an increase on the more hedge fund side of things – more distressed or event driven-type strategies; more evergreen structures versus the drawdown-type structures."
"From an investor perspective, it's vital not to ignore credit as an asset class," says Anish Mathur, chief investment officer of Astra Asset Management, which is targeting a range of relative value and hidden arbitrage opportunities in the asset- and mortgage-backed securities sector.
"It's really a time where you can differentiate one manager from the other – if people are looking for alpha, they should look at specialist managers. Asset-backed credit provides one of the best quality, substantial and sustainable returns."
He adds: "There hasn't been a lot of expertise left in the market on the areas that are more complex than vanilla lending. The time has now come back again for active investing."
Overall, demand for hedge fund strategies across private wealth outfits, institutional investors and asset managers/funds of funds remains solid – with roughly a quarter of private wealth firms (27%) and asset managers/FoFs (23%) planning additional allocations hedge funds in 2023, slightly more than institutional investors (20%).
However, survey data suggests a much bigger churn within the private wealth sector: here, allocators are also much more likely to slash their hedge fund holdings next year – one in five private managers say they plan to do so, compared to one in 10 institutional managers (See chapters 3 and 4 for further discussion about private wealth and institutional allocators' allocation plans, respectively).
"Overall, there certainly is a lot of continued appetite for alternative strategies of all shapes and sizes," says Darren Wolf, global head of investments, Alternative Investment Strategies at abrdn. "Investors need to get returns from somewhere, and traditional markets are just not offering them the forward-looking returns relative to the underlying risk."
This article first appeared in Hedgeweek's December 2022 Insights Report, Investor Interest