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Hedge funds have entered a new era. After years of global disinflation, a new market regime has taken hold, with rising rates and the return of inflation. This is leading to increased dispersion across sectors and asset classes. As one of the longest-standing investors in hedge funds and a leading European player in the sector with a dedicated team of 25 experts, UBP believes that the time has come to once again consider hedge funds as part of a portfolio allocation.


On the whole, hedge fund strategies have limited sensitivity to traditional markets such as stocks and bonds. This is because they buy undervalued assets which they hedge by short-selling similar assets that are overvalued, and make a profit when the valuation spread finally narrows.

The return of a fundamentals-based environment

The best environments for these actively managed strategies are markets that are driven by fundamentals, where there is real price discrimination between securities, companies and sectors, and reasonable volatility. Some strategies also tend to benefit from large dislocations.

In contrast, markets characterised by compressed volatility, central bank and government intervention, and persistently low interest rates, as was the case between 2008 and 2020, do not provide attractive opportunities for hedge funds. As a result, during this period, hedge fund strategies underperformed equities and returned no more than government bonds. They provided some diversification benefits, but the risk/reward ratio was relatively unattractive.

The industry has matured

These tougher times have allowed the industry to mature. Regulators set their sights on hedge funds in an effort to improve transparency and accountability. As a result, the rate of creation of unstable start-up funds with low assets under management has dropped due to increased regulation and operational and financial burdens. In addition, UCITS laws have made it easier for investors to expose their portfolios to hedge funds in a more liquid form than before.

A promising future ahead

Since the second half of 2021, the financial market landscape has changed abruptly as both equity and fixed-income markets have repriced due to higher inflation and rising interest rates. Initially cheap assets have gone back up while overpriced assets have fallen. The tightening of financial conditions with the end of quantitative easing, the return of volatility and the fear of a significant economic slowdown have restored the conditions under which markets can properly assess risk. Added to this is geopolitical instability and the long-term trend away from globalisation. In this new setting, the analysis of fundamentals is taking over to determine which companies will survive and which will not. The return of increased dispersion between winners and losers is creating a fertile hunting ground for more sophisticated strategies and is opening the door to promising times for hedge funds.

Selection is key

Selection is a critical aspect of hedge fund investing. The industry offers a wide range of investment strategies and formats across asset classes, geographies and opportunities that can play different roles in portfolios. As a result, the performance dispersion at manager level within strategies can be broad. Some strategies appear to be better positioned than others to take advantage of the new market regime.
 

Opportunities with four strategies

  • Global Macro: 2022 was an excellent year for this strategy, with above-average returns. Our expectation for 2023 is for returns to revert towards their long-term averages, while remaining attractive and providing decorrelation benefits. Also, with higher cash rates and rising yields across interest-bearing assets, carry is likely to be an important component of returns. There will be ample opportunities for core global macro trades given that global economies are at different points in the credit cycle.
  • Relative Value: One investment approach that has attracted the most talent and seen the most growth in the industry over recent years is multi-strategy funds, which allocate to more than one alternative strategy in a single vehicle. Relative-value managers are set to perform in line with long-term averages in 2023. We see convertible arbitrage, corporate credit trading and multi-strategy relative-value approaches as reliable areas to add risk.
  • Event-Driven: The high inflation and rising rate environment will leave some corporates over-leveraged and unable to cope with their debt burdens. We see real potential for dispersion, spread-widening and volatility, providing an opportunity for credit managers to generate returns while capturing greater interest income.
  • Equity Long/Short: The significant increase in equity market dispersion is creating rich opportunity sets for equity long/short, and in particular for low net exposure strategies. Over the next couple of years, even if equity markets move sideways or down slightly, we expect equity long/short to provide strong absolute returns with a low correlation to equity markets.

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The team

Kier Boley, Co-Head and CIO of Alternative Investment Solutions, has over twenty years of experience of managing alternative investment teams and discretionary investment mandates on behalf of institutions and ultra-high net worth family offices. The other Co-Head, John Argi, has been with UBP since 2008 and has over ten years of experience in the alternatives industry, in New York before Geneva. They are supported by a diverse team of skilled and experienced experts – portfolio managers, researchers, and risk & data analysts.

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Kier Boley Kier Boley
Co-Head & CIO of AIS
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John Argi John Argi
Co-Head of Alternative Investment Solutions
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