Hedge Fund Opportunities

A new world of volatility

“What’s next?” That’s been the refrain among investors this year as fears of recession, ongoing covid dynamics and war in Europe roil global markets. The uncertainty extends further, to more hawkish central bank policies than many had expected, and inflation numbers that have exceeded expectations in recent months.

And uncertainty fuels volatility. Unlike the past decade, when price swings were fleeting, it seems that elevated volatility could be here to stay. As the BlackRock Investment Institute noted at mid-year, we may have seen the end of the 40-year Great Moderation – a period defined by low inflation, low volatility and low interest rates.

The hedge fund view

Hedge fund performance amid the market turmoil of the first half shows that they can be truly uncorrelated and play an important role in a portfolio. Certain managers can provide alpha while serving as a fixed income alternative with positive, stable returns and less exposure to downside risks. Alternatively, they can be an equity diversifier that participates on the upside while limiting losses during downturns.

But choosing between the winners and losers is key. There’s been a significant divergence in results, with the top 10% of funds in the HFRI Fund Weighted Composite Index gaining 35% on average through June 30, while the bottom decile fell by an average of 32%.

BlackRock Alternatives, through its hedge funds team, has been partnering with clients to design and implement hedge fund solutions since 1995, and is one of the world’s largest allocators to hedge funds. In our view, the best managers successfully navigated the recent breakdown in correlations by thinking holistically about risk management and by constructing portfolios that are resilient across market regimes in a manner that accentuates their investment skill.

Near-term: highest conviction opportunities today

We believe that many areas within the relative value discipline, which takes advantage of mispricings across related assets, should continue to look attractive against a backdrop of elevated and more persistent market volatility.

We also think the extraordinary moves across commodities will likely continue, as investors digest supply/demand imbalances, geopolitical events and recessionary fears. That’s in addition to longer-term themes including energy transition, environmental considerations (such as changes in crop patterns) and underinvestment in key infrastructure.

Developing: ongoing and future opportunities

The new market environment will require some getting used to – investors are seeing a new set of conditions that could impact valuations, correlations, and tactical trading.

Multi-strategy and quantitative managers, as well as funds with less sensitivity to directional market and factor moves, are likely to be good, persistent ballasts across the market cycle. We’re highlighting quant not only because of the strategy’s dynamic attributes in the current environment but also for its potential to present new investable opportunities as the universe continues to evolve.

Additionally, credit is an area that possess both near-term and developing opportunities that should be watched closely, given the improved backdrop for liquid credit opportunities and potential for the distressed debt space to quickly become more attractive.

Investor dynamics

Volatility, in general, results in more opportunities for hedge funds and many investors are reaping the diversification benefits of a successful hedge fund allocation. However, given the wide dispersion in performance, some investor allocations have underperformed and those investors are looking to upgrade their manager allocations. But often, the capacity dynamic with top performers introduces further challenges, as many are oversubscribed – limiting the ability to allocate capital without negotiated capacity agreements already in place.

One option is to invest with an emerging manager, but often the most promising new managers are very selective about the investors they wish to engage with. Working with a partner who has these established relationships can be helpful to investors looking to get access to highly sought-after capacity.

It’s worth noting that with markets as volatile and fast-changing as they are today, it’s key to have capital pre-deployed with managers so they can take advantage of opportunities. Waiting for a trend to materialize before allocating to a strategy usually means missing out.

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