Within the hedge fund industry two strategies that we have a constructive outlook for 2024 are credit long/short (primarily high-yield focused funds) and global macro. Within credit markets spreads have tightened substantially in 2023 and are back to average levels from a historical perspective. The drivers behind this have been largely technical in nature, including a shrinking high-yield universe in 2023 due to rising stars (i.e. high-yield companies upgraded to investment grade) and a lack of new issuance as companies look to put off refinancing until rates start to fall.
At the same time, default rates have started to increase and bond exchanges – which is another term for restructuring, but which does not formally count as a default –increased sharply in 2023.
As a result, in 2024 we could see spreads at index level remain the same, with positive technicals pushing spreads tighter, but deteriorating fundamentals pushing spreads wider, as not all companies and sectors will be impacted in the same way. As a result, dispersion between good and bad companies and sectors should increase in the months to come. This environment should generate plenty of opportunities for credit long/short strategies.
Credit long/short funds typically build portfolios of long and short positions in developed market, high-yield corporate debt, generating returns from both high coupon income and capital appreciation. Managers aim to be long on a bond when they expect the credit quality of a company or index to improve, and short on a bond when credit quality is expected to deteriorate. For the top tier of credit long/short managers our expected return over the next 18 months is net 9 to 11% p.a. driven by a combination of positive net interest carry, capital gains through active trading and idiosyncratic manager alpha.
For global macro managers, expected returns are highly sensitive to central banks’ interest rate policies, primarily the US Federal Reserve’s.
If interest rates remain higher than the market is currently pricing, profitable trades will be longer-term broadly positioned short rates and long USD – even with the recent market pullback. Conversely, if the Fed has to cut rates aggressively then typically trades that are positioned long the front end and carry-based strategies that take advantage of yields compressing are popular. In FX, a US economic exceptionalism theme led to USD strength for much of 2023, so Fed cutting could see relative USD weakness.
Finally, EM assets are also a source of expected P&l as many of these countries have already undertaken significant tightening and with inflation stable, this provides local central banks with room to cut rates. As with credit long/short, our expected return for the top tier macro managers over the next 18 months is net 10 to 14% p.a. driven by a combination of high returns on unencumbered cash, high carry, potential rate compression and idiosyncratic manager alpha.