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Man FRM: Equity and macro hedge funds can capitalise on climate focus

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With the COP26 climate summit underway in Glasgow, equity long/short hedge funds can capitalise on the renewed focus on sustainability, while climate change and energy price volatility heralds opportunities for certain macro managers.

Hedge funds may have endured a bumpy patch in the third quarter, but Man FRM’s chief investment officer Jens Foehrenbach is upbeat on the sector’s Q4 prospects.

Man FRM’s Q4 Quarterly Outlook said the heightened focus on environmental, social and governance (ESG) factors heralds fresh investment opportunities for equity long/short hedge fund strategies, which have suffered lately as a result of crowded long trades – particularly in technology and growth stocks that often struggle in rising interest rate environments.

Investors and consumers alike are now forcing companies to re-evaluate their environmental and social impacts.

As a result, “thematic funds will naturally benefit from a clear divide in “winners” and “losers” of the energy transition and/or move towards carbon neutrality,” Foehrenbach observed, noting that hedge funds can capitalise on this distinction.

Elsewhere, the potential for alpha generation in Chinese equities may prove “limited in the short term” thanks to the impact of the Evergrande debt crisis on stock market volatility there.

But healthcare stocks stand to gain from structural and secular tailwinds, Man FRM – the funds-of-funds unit London-headquartered, publicly-traded global asset management giant Man Group – noted.

“An aging population and increasing wealth in emerging markets should boost demand for drugs, treatments, and medical care, whereas technological innovation could create new opportunities across the sector,” the outlook said.

Elsewhere, Man FRM remains positive on discretionary macro and event arbitrage strategies, neutral on credit long/short, and a negative distressed credit.

On macro, Foehrenbach suggested managers can generate returns from the transition to tighter monetary policy and asset class volatility stemming from inflation.

“Macro managers have proven to be additive to portfolios as they have the potential to add convexity. We are focused on sourcing managers with a regionally unconstrained mandate,” he said.

He added that the quantitative macro space stands to gain from the “exceptional opportunities” in European gas and power price volatility in the immediate term while, longer term, the importance of inflation expectations, climate change and China’s reopening will be drivers of returns and investment opportunities.

In relative value-focused hedge funds, event driven merger arbitrage managers continue to benefit from a strong flow of deal activity across all regions, especially large cap mergers which can absorb a lot of arbitrage capital and keep spreads wider, he added.

Reflecting on the potential risk of stagflation, the note indicated, convertible managers could benefit from higher underlying stock volatility, while structured credit could be squeezed by weakening collateral values and higher borrowing costs. Certain equity long/short managers would struggle unless they are “nimble and factor aware”, while trend followers would likely struggle in the transition period from inflation to stagflation.

Foehrenbach added: “The increasing risk of a significantly more challenging market backdrop driven by persistent inflation has led us to adjust portfolios by reducing risks where necessary, while concentrating on hedge fund strategies that offer the best opportunities in the coming quarters.”

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