Global hedge funds plan 2023 around inflation risk
AFTER weathering a dire 2022, many global hedge fund managers are preparing for persistent inflation this year and seeking exposure to commodities and bonds that perform well in such an environment.
Most of the 10 global asset and hedge fund managers surveyed by Reuters said that commodities were undervalued, and should thrive in 2023 as global inflation stays elevated.
Their other top picks included inflation-linked bonds to shield against price rises and selective exposure to corporate credit, as higher interest rates restore some differentiation in company bond spreads.
High on their list of assets to avoid or short-sell were equities. Stock markets were whipsawed last year by the sudden tightening in monetary conditions, and the earnings of many companies could be eroded further in 2023.
Jordan Brooks, co-head of macro strategy at US$143 billion AQR Capital Management, told a conference last month: “Equity markets seem to be pricing in what I would call the impossible trinity... that we’re going to have lower rates, we’re going to have disinflation and earnings are going to remain resilient.”
He said that scenario was too optimistic and recommended a risk-parity investment approach, which gives weighting to the riskiness of assets across stocks, bonds and commodities.
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Investment data firm Preqin estimated hedge fund returns were minus 6.5 per cent in 2022, the biggest fall since a decline of 13 per cent in 2008 during the global financial crisis. It said that just 915 hedge funds were launched in 2022, the lowest number in 10 years.
Crispin Odey, a London-based hedge fund manager, bet that inflation would remain high. He profited last year from short positions on British government bonds, with his OEI MAC fund ending the year up 145 per cent for the year. Although he has reduced his short position in gilts, he has remained long on inflation-linked gilts.
“Commodities will start to rise again. They’ve sold off very heavily and are below operating costs in many instances,” he said. “But owning sterling – if that breaks, that will be a very serious break. I don’t know when that will come, but it may.”
Most of the hedge fund managers Reuters spoke to think long-short equity strategies will remain out of favour after last year’s underperformance, while macro-driven strategies that exploit volatility and can be long or short any asset will extend a strong run.
“We’re bullish on strategies that take advantage of volatility,” said Joe Dowling, global head of Blackstone Alternative Asset Management, which oversees roughly US$80 billion invested in hedge funds.
“It’s the perfect environment for macro hedge funds: central-bank policy divergence, interest-rate differentials, geopolitical tension, bottlenecks and each country on its own. It presents a ton of opportunities.”
Macro hedge funds led the industry performance in the year to November, up 8 per cent, said financial data firm HFR.
Kevin Lyons, senior investment manager at abrdn’s hedge fund solutions, which has US$14 billion allocated to external hedge funds, said he expected a mild global recession in the year ahead.
He was keen to allot more to macro hedge funds, and also thought there were good opportunities in corporate credit.
“If you can find a good company with a good balance sheet, chances are they’re trading at a wider spread than they were three years ago. And you’re getting paid to sit through what could be some volatility right now in markets.”
Danielle Pizzo, chief strategy officer at Schonfeld Strategic Advisors, which manages allocation to multiple strategies, also aimed to focus more on investment-grade and high-yield bonds this year, as well as commodities.
Making the bearish case for such credit was Boaz Weinstein of US$9 billion Saba Capital Management, which has been shorting European corporate credit all year.
“There is a high risk that something in the market will break... whether because of inflation or because some sector creates a wider spread of defaults,” he said. “Our base case is that credit risk is going to be challenged next year.”
Stay out of stocks
Andrew Swan, head of Asia ex-Japan equities at Man GLG, was apprehensive of companies in Asia that are exposed to developed markets, where he expected inflation problems and slower growth.
He said: “We are negative on Taiwan generally, which is more exposed to global growth.”
Most hedge funds that Reuters spoke to were bearish on equities, especially if the Federal Reserve (Fed) kept raising rates to fight inflation.
Kenneth Tropin, the founder and chairman of US$19 billion Graham Capital Management, noted that Fed funds futures were priced for US rates to peak at 5 per cent in 2023, and drop to 3.5 per cent by mid-2024. This implied that the market expected inflation to cool considerably over the course of the year.
But he believed this was too optimistic: while it takes longer for inflation to calm, the economy will slow. “I am not convinced that equity prices truly reflect this erosion in earnings. I think stocks look expensive.”
As was the case in 2022, the correlation between individual stocks would likely be high this year, making it challenging to execute long-short strategies, some of the fund managers said.
While stocks fell last year, their moves were controlled and slow, crushing volatility trades too.
Raanan Agus, global co-head and co-chief investment officer of Goldman Sachs Asset Management’s Alternative Investments & Manager Selection, said his firm was “focused on hedge funds that are non-market or lesser-market correlated”. REUTERS
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