Alternative investments Portfolio stabilizers
In a world of extremely low bond yields and cyclical uncertainty ahead, holding a diversified portfolio of hedge funds (HF) continues to make a lot of sense. Performance of seasoned HF managers is likely to remain moderate, but still above investment grade bonds.
To the end of August 2019, the performance of the broad hedge fund index (HFRI index) was in the mid-single digits in USD terms. That was significantly better than in 2018 (-4.7%), but close to the ten-year average of 4.28%. Moreover, the dispersion of returns among the different HF managers was high, with a number of them generating negative returns.
Specialized manager selection is paramount
While hedge funds have increased leverage over the past decade, we believe a more institutionalized approach to risk management as well as more prudent liquidity measures mitigate several of the risks. Thus, unlike the years preceding the 2008 global financial crisis, the industry rewards investors with lower risk, but also more modest returns.
That said, the industry’s returns as a whole also remain somewhat exposed to traditional assets. In the environment we project, we believe that seasoned HF managers with a demonstrated ability to create value throughout the cycle can perform well. Thus, going into 2020, specialized fund manager selection is paramount in our investment process.
An allocation to hedge funds acts as a stabilizer in portfolios.
Barometer favors low beta funds
The Credit Suisse Hedge Fund Barometer, which measures market volatility, liquidity, systemic risk and business cycle indicators, provides a guide to clients as to which types of HF exposures are appropriate given any particular market regime. The latest reading of the Barometer is in the negative range, which suggests that exposure to equity market risk (beta) within the HF universe should be avoided.
This speaks in favor of diversified macro and opportunistic long/short equity strategies, as well as uncorrelated strategies that seek exposure to alternative risk premiums such as momentum or carry. This allows the HF allocation to act as a stabilizer in portfolios. Beyond specific strategies, it remains key to rely on experts who perform extensive and highly informed due diligence on the various HF managers.
Global economyWe expect only sluggish global growth in 2020 of 2.5%, almost unchanged from 2019, but a recession continues to look unlikely given supportive macro policies. De-escalation on the trade war front will be key.
Main asset classesMost asset classes showed a strong performance in 2019. Investors should not expect to see this feat repeated in 2020, although financial assets will likely continue to benefit from generally low yields.
Investment strategy 2020Now that interest rates around the world have reached record lows or slipped into negative territory, even risk-averse investors will need to buy higher-risk assets to generate positive returns.