After a decade of accommodative monetary policies with low rates, in early 2022 market conditions once again became better suited to more sophisticated strategies that play on risk. The resulting contrast between equity and bond indices’ 10% fall and alternatives’ rise is stark.
This is particularly noticeable in the case of hedge funds, which Union Bancaire Privée’s Kier Boley believes are making a big comeback. He is in charge of alternative investments at UBP, managing some 16 billion dollars (out of the 150 billion which the bank has under management). We took the opportunity of his visit to Geneva to speak to this hedge fund veteran, who spent over 20 years with GAM.
How did 2022 go for alternative investing given both the unexpected events and the rapidly changing monetary policies?
We did quite well. In particular because our equity fund choices were often skewed towards managers with low net exposure, which overall posted returns of between -3% and 5%. Many equity managers had a strong growth bias at the beginning of the year, which in some cases led to higher losses than expected for them.
However, global macro-oriented funds and CTAs (editor's note: ‘commodity trading advisors’ – a manager or entity that applies an investment strategy using liquid futures contracts and options on them) are the ones that generated the best performances, with gains of between 15% and 25% in 2022. It makes sense that they should be the best positioned to benefit from one of the year’s central themes – inflation, a macroeconomic phenomenon – with investments in particular in fixed-coupon bonds and currencies.
The key when you have performed well in a difficult market environment is to know when you’re coming to a turning point and when to adapt your portfolios.
At UBP, we believe that there is still a significant economic slowdown ahead and that equity valuations don’t yet reflect that.
There has been a string of crises and central banks have not yet fully unveiled their plans for the future – isn't it difficult to make reliable forecasts?
The bank's investment committee is very clear on the outlook for next year and we agree. The going is about to get a bit tougher for equities, which face a contraction in earnings. This means that bonds should outperform equities in 2023, providing some protection via income while markets recover. If you want to invest in equities in the near term, timing will be crucial as they are still too expensive in the US at this point in the cycle. So, investment-grade debt is really a good place to be at the moment.
After a decade or so of unusually low rates, how does alternative investing look now?
We are entering a new era for hedge funds, where the markets can once again assess risk properly. It's the end of a ten-year period where central banks decided that they could control market valuations with expansionary policies due to the lack of inflation. Now that inflation has returned, policymakers are having to step back their intervention on capital markets. The whole point of hedge funds is to buy undervalued assets on the one hand, and hedge them by short-selling similar assets that are overvalued and make a profit when the valuation spread finally narrows. For the last ten years central banks’ quantitative easing made expensive assets even more so, while no one was interested in cheap assets. This meant that hedge funds’ performance dropped from 13% a year to about 5%.
In 2022, things changed abruptly when initially cheap assets went back up while the overpriced ones fell, technology stocks being just one example. This return to a market where the more realistic cost of capital makes it truly possible to determine which companies will survive and which ones will not provides a better environment for active managers like hedge funds.
And what can we expect next year?
It will depend on inflation. If it slows down quickly, it is not impossible that the US Federal Reserve will reverse rates entirely and we will be in the same situation as between 2010 and 2020. However, it’s more likely that rates will stabilise in 2023, which would be good news for hedge funds as risk-free rates would remain at 4%.
Companies having to refinance at higher costs is also beneficial to hedge funds. Waiting for what the Fed will do with its rates adds uncertainty, but we remain optimistic. Hedge funds will probably not return to annual gains of around 13%, but we can already see a jump to an average of 8–9% from 5–6%. This is welcome news compared to equities and bonds, and excellent news after the figures of the last ten years.
If inflation remains in line with central banks' objectives, will things still go back to the way they were before the 2008 crisis?
The 20-year period up to 2010 is considered by everyone to be a golden age when it was natural to increase exposure to hedge funds because they were at the cutting edge of efficiency. Today, investing is done differently and that’s irreversible, even if we went back to the way things were. However, it will be interesting to see how investors react to higher default rates and bankruptcies. This means, among other things, that there will be more short-selling.
Listed companies will probably also have to raise capital, with sudden price drops for some stocks and thus opportunities for alternative managers. This is linked to these companies’ debt problem, which is coming to the fore as they can no longer finance themselves cheaply. They must now focus more on their free cash flow rather than pure growth. So, 2023 will be a good year for active managers.
You talk about a changed way of investing, what do you mean by that?
At times hedge funds have had a bad reputation. Especially because many funds were actually start-ups running many new projects, with the normal failure rate that goes with that. The tougher times over the past 10 years have allowed the market to mature.
The alternatives industry as a whole has changed dramatically and is now predominantly made up of large, well-regulated groups.
Investors have also evolved in their mindset and now look more at the longer term with a more quantitative assessment of the value managers add to a portfolio. For UBP, the decision to retain in-house alternative investment experts makes us better able to now find the talent we want to work with.
Kier Boley