UBP's experts are reviewing performances by strategy since the start of the year, a period that has seen positive returns overall. They anticipate that the momentum should remain favourable for the industry, with particular strength in non-directional equity long/short and global macro strategies, and those focused on fixed income.
In the first quarter of 2023, the upward trend in risky assets persisted, as markets were pricing in that interest rates had already peaked. Equity and fixed income markets were positive across the board, both in developed and in emerging markets. Commodities were down, driven by energy prices. The most significant event of the quarter was the confidence crisis around regional banks in the United States, as well as the Swiss government’s engineered purchase of Credit Suisse by UBS.
In the hedge fund industry, most strategies performed positively during the quarter. Directional strategies within equity long/short and event-driven had the strongest returns, with the HFRI Equity Hedge (Total) Index posting a gain of 3.4% and the HFRI Event-Driven (Total) Index up 1.4%.
On the flip side, the strong reversal in bond markets impacted global macro/CTA managers. Losses were posted by the majority of managers who had been positioned short front-end rates on the basis that inflation remained strong and central banks would have to maintain a tightening bias. The increased clouds gathering around the economy also had an adverse impact on M&A spreads.
The return of dispersion
Regarding the performance outlook over the next 12 to 24 months, UBP’s alternative investment experts remain consistent with their previous quarterly reports. Markets continue to be driven by macroeconomic factors, with a focus on the Fed and economic data. A growing consensus is pointing to an upcoming recession, which may shift markets’ attention back to corporate fundamentals, leading to a return of dispersion.
Within the equity long/short space, the expected increase in equity market dispersion should lead to a renewed focus on specific company fundamentals, creating rich opportunity sets for less directional or low net exposure managers. Even if equity markets were to move side-ways or modestly down in the coming months, low net long equity long/short strategies should provide absolute returns with a low correlation to equity markets. In that context more liquid strategies or an equivalent should be favoured as they enable rapid repositioning if the equity market outlook improves.
The macro strategy can benefit from very different market regimes, including both from the recent inflationary market focus and from a recession fear focus that may favour defensive exposures like long bonds, yen and long value/short growth. However, inflation trends remain the overriding economic issue, and as we approach a peak in rate-tightening we should expect more risks to materialise.
Credit & Event-Driven
The high inflation and rising rate environment should leave some corporates overleveraged, providing potential for dispersion. The recent banking crisis has led to the postponement of deal announcements and reduced M&A activity to low levels. However, market data shows that the global deal pipeline remains robust. When market activity picks up, merger arbitrage should generate returns close to its long-term average.
Convertible arbitrage, corporate credit trading strategies and multi-strategy relative value approaches appear to be reliable areas to add risk to. Relative value funds were not completely immune to the first quarter’s rate swings, but most of the rate exposure is through market-neutral, mean-reversion trades, so any mark-to-market moves are expected to be recouped over the following months. Overall, relative value strategies are expected to perform well.
Systematic strategies have demonstrated their diversification benefits during periods of macro uncertainty. Looking forward, if we see a consistent theme building – either a further sell-off on growth fears or a sustained risk-on move – then future returns can still be at the higher end of their range as the trend is adaptive and provides an opportunity to profit in either scenario. However, if we continue to see sudden shocks, such as in March 2023, or if markets become range-bound again, then returns should be at the lower end with statistical arbitrage potentially performing better than other sub-strategies.