UBS’ Edoardo Rulli discusses hedge fund alpha, AI capex risk and the rise of alpha capture.
The environment being optimal for hedge funds to generate significant returns does not coincide with the framing of this being a normal regime. Rulli believes it is fundamentally different. The era of low inflation and low interest rates has been structurally upended to a higher baseline level of inflation, and much greater volatility in its behavior. This leads to “a higher risk premium in both bonds and equities “ according to Rulli.
Finding strategies that can accommodate this regime has seen large levels of capital flow towards long/short equity. Rulli notes that UBS is running at the top end of its historical allocation towards this area. “It is a market that rewards winners and punishes losers; higher interest rates create a major line of demarcation between high-quality companies with strong balance sheets and lower-quality businesses with high leverage.” In addition to long/short equity being a preferred allocation, UBS has also gravitated towards event-driven strategies to capitalize on the flurry of IPO and M&A market activity and commodities, in a world where supply constraints create a fertile hunting ground.
UBS allocates both to specialist funds and larger multi-strat platforms. Rulli believes that despite potential question marks surrounding the larger pod-shops, regarding concentration and leverage concerns, they will still be a primary allocation for investors. “Talent attracts talent, great teachers attract great students. Multi-strategy firms are becoming the Ivy League of investing, where talent continually attracts more talent.”
A recent development for these large platforms has been to launch buy-side alpha capture programmes, to open new avenues to deploy there ballooning levels of capital. Rulli sees this as a positive development for smaller platforms: “We’re beginning to see more targeted standalone offerings, and those are becoming increasingly interesting.” For UBS, they would be particularly drawn to having direct access to alpha capture strategies, rather than through a manager. Rulli believes this would potentially “allow investors to replicate part of a multi-strategy portfolio at a fraction of the costs while tailoring exposure to complement the rest of their allocations.”
Despite his admission that this is an ideal alpha generation environment for funds, there are certain areas of the market that concern Rulli. One is AI Capex expenditure, we have seen this becoming a key barometer in the AI buildout. The growing expenditure levels are being less and less justified by the market, who fail to see the corresponding revenue growth. A secondary area of concern is the growing threat of cyber risk: “AI in the wrong hands could cause enormous damage; a major cyberattack involving theft of access to bank accounts or digital financial infrastructure could create a broader crisis of confidence.”
