A blistering rally in stocks and elevated bond yields are pressuring global hedge funds to boost returns as they fight to staunch investor outflows, industry insiders say.
Investors have pulled about a net $75 billion from hedge funds so far in 2023 and allocations to the $3.4 trillion industry have slowed, data from Nasdaq eVestment showed. The outflows come on the heels of some $112 billion that left hedge funds last year.
Hedge funds in 2023 averaged a 5.7 per cent return this year through November, according to hedge fund research firm PivotalPath. Strategies focused on equities and credit were the best performers, while macro and managed futures lagged.
In contrast, the S&P 500 is up about 24 per cent this year, as of December 20. Hedge funds are also competing with returns from bond markets, which have perked up thanks to a late-year rally: Bloomberg’s US Aggregate Bond Index has risen 4.88 per cent for the same period.
At the same time, elevated yields across asset classes have bolstered the allure of money markets and other short-term vehicles, where investors can collect around 5 per cent or more with a comparatively low level of risk.
“Some strategies that historically have been very conservative, yielding 5 per cent-6 per cent, are less attractive now because investors can get similar returns in cash,” said Fredrik Langenskiold, senior investment specialist, alternatives at UBP.
Strong performance in a wide range of asset classes puts pressure on hedge funds to boost returns next year. Rebecca Adel, at Societe Generale’s EMEA capital introduction team, said allocators would be seeking double-digit returns in 2024 and are interested in credit, global macro, commodity and equity long/short strategies.
One potential strategy involves funds adopting “barbell” portfolios with corporate and structured-credit hedge funds on one side and macroeconomic hedge funds providing alternative exposure on the other, said James Medeiros, president of Investcorp-Tages, which has “funds of funds” investing in hedge funds and also runs its own trading strategies.
Bond-trading hedge funds may benefit as higher rates increase costs for cash-hungry companies that have bonds and loans due for refinancing.
“You can get sort of equity-like returns on bond products, which is pretty attractive,” said Zhe Shen, managing director of diversifying strategies at TIFF Investment Management, advising endowments and foundations on hedge fund investing. Shen said they had also added macro strategies to portfolios.
The S&P US High Yield Corporate Bond Index is up 10.74 per cent year-to-date.
Others are looking at hedge funds that trade bonds in a range of different strategies: taking long and short positions, packaging up corporate loans into bonds, and trading the relative values between bonds.
Global bond traders tracked by HSBC returned about a positive 7 per cent so far this year to December 8, the bank said in a note to clients. “Now it’s a good moment for credit, because dispersion of returns is higher than in previous years, while rates and spreads are still appealing despite the recent rally,” said Mario Unali, senior portfolio manager at Kairos Partners. The firm, which manages a fund of funds, aims to increase the credit component of the portfolio for the first time in 15 years, mainly in high yield.
Macro trades
Investors are also eyeing hedge funds seeking to trade on macroeconomic signals that affect assets from bonds to equities and commodities.
Global macro hedge funds are up 1.7 per cent in 2023, hampered by this year’s rollercoaster ride in markets and a banking crisis in March, compared to a return of 11.5 per cent in 2022, PivotalPath data showed.
Some investors are betting the strategies – which thrive on disparate global trends – will see a strong year in 2024, with central banks expected to loosen monetary policy at varying speeds.
While bond yields, which move inversely to prices, have generally eased in the last quarter of 2023, worries over bond supply could persist in 2024 and keep yields elevated. Concerns over bond issuance helped take Treasury yields to 16-year highs in October.
“There should be too much bond supply next year” given the “bad” fiscal positions of major economies, said Shun Hong Liu, chief investment officer of macro hedge fund Hong Investment Advisors.
One key element will be an expected slowing of the global economy, said Doug Greenig, chief investment and executive at Florin Court Capital, a $2 billion systematic hedge fund.
“The global picture going forward will be economic weakness, a negative for corporate profits,” said Greenig. “Equity markets could end up in a tug of war between a lift from lower interest rates and a drag from fears about earnings.”