Risk management and asset allocation have been taking centre stage as interest rate risk and uncertainty have continued to impact markets. A cautious approach with little to no leverage can help hedge fund investors navigate this state of affairs successfully.
Risk management and asset allocation have been taking centre stage as interest rate risk and uncertainty have continued to impact markets. A cautious approach with little to no leverage can help hedge fund investors navigate this state of affairs successfully.
“In the current rising interest rate environment our clients focus on risk management has increased significantly,” explains Don Davis at Prime Meridian, “A consistent theme we have heard from our clients is that they appreciate our risk management and how we have preserved and grown their capital base in a very difficult market environment.”
In order to mitigate and seek to minimise interest rate risk, the firm has built very short-duration portfolios. This also allows Prime Meridian to capitalise on a rising interest rate environment. This approach is bearing fruit as the firm is seeing 200-300 bps higher yields on newly originated loans as compared to the start of the year. Davis notes: “As new capital is put to work from re-investment of cash flows as well as new investor deposits, we would expect to see rising investor net returns in 2023.”
The unlevered Prime Meridian funds, which comprises short-duration, high yielding credit portfolios, are well positioned to navigate an environment in which the risk of continued policy errors and further economic deterioration will adversely affect most businesses and investments.
A key element in the firm’s investment philosophy hinges on the practice of non-correlated asset allocation. Davis outlines: “Investors have been reminded that there’s not much diversification in owning a basket of stocks, and sometimes there’s not even much diversification in owning a basket of both stocks and bonds, which have both netted double-digit losses year-to-date.
“We truly want our clients to do very well with all of their investments; but when it comes to their investments in any of the Prime Meridian funds, capital preservation and consistent profitability are our primary objectives. Having a short-duration and high yielding portfolio has enabled Prime Meridian to preserve client capital and to deliver steady returns with low correlations to both the stock and bond markets.”
This stability and cautious approach are critical in an environment where some highly leveraged hedge funds may collapse in the first quarter of 2023, as is often the case in every Fed tightening cycle. “Nevertheless, overall, I think there will be an increase in the appetite for hedge funds, especially those focusing on lower risk alternative credit strategies that use little to no leverage such as the Prime Meridian funds,” Davis concludes.
