Hedge Fund Strategies Gaining Momentum in 2021

As hedge fund managers finalize their quarter-end performance, returns have been surprising some investors — in a good way. For the first 6 months of the year, the hedge fund industry has boasted a close to 10% return, marking the industry’s best first-half performance since 2009. In fact, performance has been near or better than 2021’s returns only three times in the last 20 years: 2000, 2003, and 2009. Below we detail some of the top performing hedge fund strategies for the year so far, recent trends indicating an increase in hedge fund appetite, and how you can implement these ideas for your clients’ portfolios.

Among the top-performing hedge fund strategies were commodity-focused and equity-focused funds for 1H21, which respectively returned +15.22% and 12.16% YTD returns. Second to those strategies was Origination & Financing funds, which provided investors +9.53% YTD return. FX/Currency funds posted a strong June MTD performance of +1.45%, which brought them into the positive territory of +0.69% YTD.

Following the recent hedge fund performance, the Hedge Fund Confidence Index released results of their survey finding that 80% of the 108 investors surveyed were satisfied with hedge funds’ performance for the first half of the year.

Tom Kehoe, Global Head of Research and Communications at the Alternative Investment Managers Association, noted, “Investors saw what hedge funds could do [during the pandemic] and historically… Hedge funds are able to navigate the drawdown; they’re best able to manage risks. And there are certain strategies that set out to do that.”

In the first half of 2021, asset owners considerably boosted their hedge fund investment pace to help deliver returns and diversification, allocating to hedge fund strategies, detailed in the diagram below, to safeguard their portfolios from increasing inflation, higher interest rates, and higher volatility.

In May, investors poured an estimated $12.01 billion into hedge funds, bringing the total net inflow for 2021 to $39.12 billion contrasting from the $59.3 billion of outflows in 2020, according to data from eVestment LLC.

In an interview, Luke Ellis, CEO of Man Group PLC, stated, “The No. 1 topic institutional investors want to talk about is inflation, but what they really are talking about is their bonds. All institutional investors will be impacted if inflation rises because those bonds will go down in price a lot…If the Fed raises rates, the front end of the yield curve pushes up, or if they don't raise rates, the bond market will sell off.” For an increasing number of investors, the solution is to use hedge funds as a fixed-income replacement, with a likely mix of low-net equity, credit, and macro funds, according to Ellis.

An example of the preference changes is the recent allocation made by Los Angeles County Employees Retirement Association to the noted hedge fund strategies. LACERA currently manages $69.6 billion of assets and approved an $850 million investment in four hedge funds for the fiscal year ending June 30.

● Discretionary global managers: Brevan Howard Asset Management and Caxton Associates LP

● Asia-focused relative-value multi-strat fund: AM Squared Ltd

● Hedge funds emerging manager program: Stable Asset Management LP

Senior investment officer for LACERA, Chad Timko, notes the changes into these hedge fund strategies emphasize their portfolio’s risk mitigation and return targets with low correlation to equity markets.

Upon generating strong returns for 1H21 and witnessing renewed interest from investors, hedge fund managers are more optimistic about the current environment.

According to the second quarter Hedge Fund Confidence Index from AIMA, Simmons & Simmons, and Seward & Kissel, on a scale from -50 to +50, hedge funds assessed their economic confidence at +19.5, up from an average of +18.4 the previous quarter. Confidence has also increased dramatically since the fourth quarter, when it was at +13.8. About 80% of hedge fund managers surveyed reported feeling optimistic about investment opportunities over the next 12 months as the world begins to reopen from successful vaccination rollouts.

Among the hedge fund strategies in the report, multi-strategy funds reported the highest confidence level at +22. Following multi-strategy, long-short equity, long-short credit and global macro funds each scored +18.8.

● Multi-Strategy Funds: Multi-strategy funds continue to generate high returns for investors; in particular, several of the biggest funds in this category have posted consistent solid returns over the quarter, resulting in their garnering the lion's share of institutional capital investment.

● Global Macro Funds: Global macro funds are excited about the upcoming volatility from inflation risk creating opportunities for the funds to outperform

The report states, “Increasingly investors are looking to the qualities that hedge funds demonstrate in being able to manage any downside risk from market volatility as well as the heterogeneity of their investment strategies which can provide the best potential for significant diversification as well as the highest potential for generating out-performance.”

The report describes the following trends that investors are looking for in hedge funds:

● Preference for strategies targeting a wide investment universe: exposure across multiple asset classes (i.e. public equities, private companies, private credit, and real estate) provides diversification for investors

● Unique hedge funds: investors are looking for new opportunities tailored to meet their needs

● Protect against inflation: funds providing stable return and limited downside risk are seen as a fixed-income replacement for investors

Against the backdrop of the noted investor preferences, below are hedge fund strategy suggestions to meet those portfolio needs:

Global Macro Funds

● Definition: funds using long and short positions in a variety of products (i.e. options, futures, currencies, FX, fixed income, commodities) to make market bets on economic events

● Rationale: expected to provide uncorrelated returns based on positioning

Multi-strategy Funds

● Definition: funds with various portfolio manager teams trading different strategies under a single portfolio mandate

● Rationale: provides diversified exposure across multiple asset classes and sectors under different trading teams

Private Credit

● Definition: funds focused on credit investments not widely traded in the public market or one-off transactions from private companies

● Rationale: private credit trades often carry a higher return potential through illiquidity premium and complexity trade

While it is nearly impossible to predict the market, we can rely on the market’s ever-changing nature. Partnering with managers equipped to handle market volatility may help protect portfolios against the downside. As institutional investors are upping their allocations to hedge funds in the prevailing strategies, financial advisors with similar downside protection mandates can look at the active management of hedge funds ahead of the uncertainty.