Hedge funds can combat inflation surge as economies begin to unlock, says K2 Advisors

As global economies prepare to unlock, potentially driving up inflation and interest rates, hedge funds’ low sensitivity to rate moves can help bolster investors’ portfolio performance, says K2 Advisors, the hedge fund investing unit of Franklin Templeton.

As global economies prepare to unlock, potentially driving up inflation and interest rates, hedge funds’ low sensitivity to rate moves can help bolster investors’ portfolio performance, says K2 Advisors, the hedge fund investing unit of Franklin Templeton.

With economic growth tipped to trend higher, fuelling inflation, hedge fund strategies can deliver a diversifier to certain fixed income assets that may face a squeeze during inflationary or rising rate environments, said Brooks Ritchey, K2’s co-head of investment research and management.

Hedge funds and other alternative investment strategies have traditionally been seen to thrive against equities and fixed income in low interest rate environments. But falling Covid cases and an accelerating vaccine roll-out across developed markets may now send consumer and industrial demand soaring, pushing global inflation trends and interest rates higher – carrying a knock-on effect for bonds and equities.

As a result, hedge funds now look “particularly interesting” as a fixed income diversifier, Ritchey explained.

“These strategies help to diversify one’s portfolio in a rising rate environment given the resultant increase in performance dispersion across regions, sectors and asset classes,” Ritchey wrote in a note on Tuesday.

“Hedge funds have the opportunity to go long the potential beneficiaries of higher financing costs and short those areas hurt by them.”

K2 – which provides a range of hedge fund and alternative investment products including single investor custom-tailored investment programmes, commingled funds of hedge funds, and strategic advisory structures across multiple strategies – noted how hedged strategies helped insulate portfolios from the initial Covid-19 stock market shock in March 2020.

“The low equity sensitivity characteristics of a multi-strategy hedge fund portfolio helped a balanced portfolio of stocks and bonds to preserve capital,” Ritchey said.

A year on, with multiple vaccines and more effective treatments of coronavirus now available, the impact of the economic recovery and rising markets on equity and bonds is coming into sharp focus.

“A large risk is the potential for a resurgence in consumer and industrial demand to push global inflation trends higher, and subsequent central bank responses, Ritchey said.

“Any growth spurt and move higher in inflationary pressures should cause global interest rates to rise and bond prices to consolidate lower.

“For now, this recovery scenario seems most likely. That said, if the virus was to mutate and the case count was to reaccelerate, markets may lower their concerns regarding growth-led inflation and the risk of higher interest rates.”