Hedge Fund Outlook: New Regime, New Asset Allocation

Key insights:

2023 has been quite eventful in many ways. Market narratives have been changing throughout the year: from recession fears and sharp rate cuts earlier this year to soft landing hopes in summer to more recently a “higher-for-longer” rates backdrop.
Investors have a challenging task ahead as we expect volatility to persist in both fixed income and equities, destabilizing their correlation, which has represented a challenge for traditional asset allocation over the past three decades. Additionally, there are secular factors that have the potential to raise inflation structurally and cause an inflationary shift in the macro environment.
2023 has proved to be a more challenging year for the hedge fund industry in aggregate, with little dispersion across strategy, and rather more among managers compared to 2022, when dispersion across strategies made top down allocation more differentiating.
Despite that, hedge funds have broadly complemented more traditional asset allocations, once again generating positive returns over last few months when both equity and bonds have sold off at the same time. Overall, we observe cautious positioning both in terms of nets and leverage vs history; which should bode well for capital preservation and ability to deploy capital into dislocations.
Cash may look attractive at current interest rate levels but holding too much means missing out on potential investment opportunities. Hedge funds are not cash equivalents, they are actively managed, flexible and opportunistic investments that can protect capital as well move quickly to take advantage of dislocations.
We believe that a prolonged period of higher cost of capital will inevitably result in some form of recession. We also believe that inflation might not return to target fast enough to allow the FED to offset a rising risk of recession in 2024. As such, we could see some violent episodes of risk-off sentiment next year, which explains our more defensive positioning at the moment.
We continue to identify very interesting, short duration income opportunities across a variety of markets and instruments, that offer lower correlation to broader markets; for example: Agency Mortgages, Residential Real Estate in US, Structured Credit, Trade Finance and selective co-investments.
Outside that, we still favor fixed income relative value (FIRV) and macro strategies which remain core allocations as they are expected to benefit from a continuation of elevated rate volatility. FIRV is still enjoying elevated spreads and high rates volatility, we are watching carefully new regulation soon to be introduced and impact on expected returns. On the other hand, we continue to reduce our allocation to commodities.
We’ve been constructing our portfolios with a capital preservation focus into what we think is still going to be a difficult environment. Our portfolios are still very low-beta in nature, market-neutral, and uncorrelated with risk parity. However, there are events and external shocks that are hard to protect from.

Speaker

Edoardo (Edo) Rulli

Chief Investment Officer, Head of ��ţ�� Hedge Fund Solutions (HFS)

Edo is responsible for managing and overseeing investments of third-party active investment strategies across hedge funds, co-investments and private credit. Edo re-joined ��ţ�� in 2016 and has over 22 years of investment industry experience.

Moderator

Roberta Fornasieri

Investment Specialist, ��ţ�� Hedge Fund Solutions

Roberta is primarily responsible for handling business development and investor services for HFS European clients and prospects. Roberta joined HFS in 2016 and has over 11 years of investment industry experience.