The hedge fund strategies set to outperform in 2024

In our first piece (4 reasons why hedge fund allocations are on the rise) we leapt straight into why our private bank partners are materially increasing their hedge fund allocations, without dwelling on:

• what hedge funds actually are;
• why they’re different to long only funds;
• and what the different hedge fund strategies are (there are many, and the multi-strategy funds generally employ many if not all of them). 

To redress this, this piece covers some introductory concepts, and descriptions of the key strategies, including how we’re thinking about each of the strategies, and allocating/ recommending allocations in 2024.

As a starting point, the key differences between the hedge fund, and broader asset management sectors are that:

• Hedge funds can access and use a broader range of instruments (at simplest, they can protect against market and price falls by shorting securities and markets, but generally have access to a full range of financial instruments, hence consistent outperformance versus indices in times of volatility and market drawdowns).
• The ability to utilize this broader instrument set is authorized in far less restrictive mandates, with fewer investment constraints – hedge funds tend to be index unaware, hence correlation with equity and other indices is low (in some case inverse), and fund managers aren’t ever faced with the requirement to be exposed to markets they don’t have a confidence in, unlike say a long-only fund with minimum exposure/maximum cash holdings restrictions.

• Dispersion is extremely high in the hedge fund sector, and persistency is high relative to public markets mutual funds, meaning that there’s an outsized performance premium to selecting and accessing the better funds (and a greater performance penalty for not selecting the better funds, unlike say a large caps long only mutual fund, where dispersion – the gap between best and worst funds – is lower, and persistency – the extent to which top quartile funds in any given period continue to be top quartile funds – is also lower).

• The breadth of strategies and profiles across the hedge fund universe makes them particularly useful for portfolio construction – whatever portfolio objectives, are, and whatever existing portfolio looks like, there are hedge funds that will improve portfolio returns, volatility and other characteristics (indeed the portfolio construction tools on our platform have been developed in conjunction with feedback from CIOs and fund allocator partners, and measuring historical correlations against both other funds and 200+ indices remains one of the most popular portal functions).

In terms of specific strategies, the sector has evolved significantly since the first long/short equity funds were launched ~70 years ago. Investors have a wide range of different strategies they can allocate to, and in our view, should actively manage allocations across strategies, or allocate to the leading multi-strategy managers, who (successfully) actively re-allocate across strategies.

Multi-strategy funds

Multi-strategy hedge funds employ a variety of investment strategies simultaneously to deploy capital across markets in a diversified fashion. Unlike traditional hedge funds, which may focus on a single strategy like long/short equity or global macro for example, multi-strategy hedge funds diversify across investments pods and/or portfolio managers. While some multi-strategy platforms will have stronger pods than others depending on the strategy (both internally and at industry level), their mandate typically allows them to deploy across all of the main strategies (long/short equity, event-driven, credit, fixed income arbitrage, quant, etc.). The diversification of platforms, combined with very tight risk frameworks tends to enhance returns by capturing opportunities across markets and cycles, while also providing strong downside protection

Some of the well known multi-strategy funds include Citadel, Millennium, Balyasny, Point72, and D.E. Shaw.

2024 Outlook

We think the multi-strat strategy will consolidate, especially following the Schonfeld-Millennium no deal. We expect funds to:

• Re-focus on fees to keep their fixed costs in-line with historical averages
• Increase discipline about capacity and asset raising
• Reduce netting, both internally for trading purposes and for clients
• Continue to acquire talent but at the “right price”
• Place increased emphasis on risk, given the shifting dynamics of crowding

We remain focused on funds that have an advantage in acquiring and retaining talent from diverse sources; whilst having institutional level infrastructure and risk. We believe this mix will result in continued strong risk-adjusted returns for investors, albeit with increasing capacity limitations

Long/short equity funds

Definition

Long/Short Equity hedge funds seek to generate returns by taking both long and short positions across equity markets (globally or locally depending on the manager’s mandate). The typical aim of Long/Short Equity hedge funds is to outperform the market indices that best refer to their spectrum of investible stocks, while managing risk and portfolio diversification to provide enhanced drawdown protection (versus the indices). Different Long/Short Equity funds will have different levels of directionality, while we at Antarctica Asset management tend to favor market neutral strategies, there exist managers with substantial beta to closely track indices up (but also down).

Some of the well know long/short equity funds include BlackRock Strategic Equity, Viking, Select Equity, Coatue, Tiger Global and TCI

2024 Outlook

Within long/short equity we are currently focused on variable net and trading funds, with high idiosyncratic risk, especially those with limited net long beta biases. There are several thematics which we believe will have enough winners and losers for funds to extract alpha from, beyond the heightened levels of dispersion. These include: AI, GLP-1, onshoring, energy transition, busted banks and real estate, Japan emerging from its lost decade(s), and an increasingly fallible China. At the same time we are positive on funds which can take modest tilts in their portfolio by leaning into opportunities, having done the deep work, whilst also being able to:

1. Concentrate and deliver alpha via sizing, not just fundamental analysis, and;
2. Elongate and shorten their time horizon depending on the regime. 

Despite recent media coverage about the performance of long/short equity funds, we cover 16 long/short equity funds and they returned 13.87% last year (average), were up 1.18% in January, and have had a strong Feb start also.

Quantitative funds

Definition

Quantitative hedge funds (generally called quant funds) employ sophisticated mathematical and statistical models to deploy capital across markets. The models they use typically analyze very large datasets (historical and actual) to identify patterns, trends, or potential inefficiencies across markets. Opposite to some of the other strategies mentioned in this piece, quant strategies seek to exploit markets as systematically as possible (versus hands-on for certain PMs/Fund managers where judgment is key for positioning and sizing). Some of the most common sub-strategies include statistical arbitrage, trend-following, market-neutral, and high-frequency trading.

Some of the well know quant funds include Voloridge, Qube, Systemetica, PDT partners, and Engineers Gate.

2024 Outlook

Equity strategies have a favorable environment given they tend to profit when volatility and dispersion are high, or at least elevated. We continue to focus on high-quality capacity constrained funds. We remain neutral on CTAs, given we believe we get the positive skewness and convexity from Discretionary Macro funds on more consistent basis

Macro funds

Definition

Global Macro hedge funds aim to profit from broad macroeconomic trends and events across different countries and asset classes (depending on their mandate and expertise). Typical strategies and factors include rates, inflation, geopolitics, policies, regulations, etc. all used to forecast outlooks and take positions anticipating how a certain market/instrument may shift depending on the aforementioned catalysts. These funds can take both long and short positions in a wide range of assets, including currencies, commodities, equities, bonds, and derivatives, based on their macroeconomic outlook. Managers may employ discretionary strategies (which we tend to favor at Antarctica Asset Management), relying on their judgment and analysis, or systematic approaches that utilize quantitative models to identify opportunities.

Some of the well know macro funds include Rokos, Brevan Howard, Garda, Tudor, Caxton, and Moore Capital Management.

2024 Outlook

The number of Fed hikes/cuts by decade has been: 1970s = 89. 1980s = 76. 1990s = 35. 2000s = 43. 2010s = 12. 2020s = 13, so far. We think this points towards potentially strong Discretionary returns amongst the Macro managers, certainly relative to the new normal era of the 2010s. In addition, given the plethora of elections (over 40), we deem it prudent to focus on funds which can navigate these events well. Fixed Income Arb has a positive outlook given the supply of capital is constrained, with primary dealers’ activity low, at the same time as volatility and term premium normalization requires intermediation capital, which this strategy can capture. Commodities remains ripe, given the sector is broadly facing long-term supply challenges, with the confluence of financing issues, green energy initiatives, and geopolitical concerns - we expect volatility, and hence alpha, to remain elevated.

Credit funds

Definition

Credit hedge funds employ a variety of strategies across debt markets. From long-only credit investing to distressed debt investing, to credit arbitrage, to credit derivatives, they typically aim to leverage the broad array of returns generation tools that credit markets offer (pricing, spreads, yields, covenants, etc.). Some of the key factors considered across the strategy include creditworthiness of issuers, rates, securities RV, default rates, etc.. Credit hedge funds tend to be particularly attractive during periods of market volatility or economic uncertainty.

Some of the well know credit funds include GoldenTree, Saba, Davidson Kemper, Silver Point, Linden, and King Street

2024 Outlook

The magnitude of credit maturities coming due, mostly in 2025-26, coupled with higher rates for longer will likely lead to a transfer of value from equity to credit. We expect material dispersion with some companies having more difficulty operating on the other side of the maturity wall than others. Today the volume of US stressed bonds (price below 90) has reached just under $500bn since June 2022 and default rates have started to increase over the last 12 months; we have not seen the same volumes in Distressed yet. This creates an attractive environment for Long/Short Credit funds with flexible and patient capital, as they are being paid to wait for fat pitches to come around and/or a full distressed cycle to emerge. Convert Arb remains attractive given the robust new issue market, as well as funds engaging with issuers around corporate liability management activities. Structured Credit is attractive, but given the economic uncertainty and potential for larger tail events we believe exposure is best managed in a Multi-Strat format, with cautious risk oversight

Event Driven funds

Definition

Event-Driven hedge funds target profits from corporate events or specific situations that can impact the value of a given asset. These events can greatly vary depending on the strategy, from mergers and acquisitions to corporate restructurings, to bankruptcies, to spin-offs, to shareholder activism, or even legal actions. Event-Driven managers tend to have strong expertise in one or a few of these events to best track or identify the most promising opportunities. When it comes to positioning, these funds typically aim to identify mispriced securities before or after events such as the aforementioned occur, anticipating how they will affect a security’s price before positioning themselves on either the long or the short side. A clear differentiation of the strategy tends to be the depth and breadth of corporate expertise required to best navigate market cycles (legal, regulatory, fiscal expertise).

Some of the well know credit funds include Third Point, Elliot, and Sculptor

2024 Outlook

We see the event driven opportunity set as being bifurcated. Merger Arb has struggled with antitrust issues, albeit the increased predictability in the review process has partially alleviated this concern. Equity Capital Markets has seen a modest pick-up in IPO activity but doesn’t suggest a complete upturn. Capital Structure Arb, with a focus on Credit, offers the most interesting opportunity to generate positive returns

While the use case for hedge funds in this environment remains strong, allocating to the sector has, and continues to be more difficult than for other fund categories.

1. Hedge funds are capacity constrained. Many of the large multi-strategy funds have long waiting lists, and return funds to investors annually so even keeping a consistent hedge fund weighting in a portfolio can involve constant re-allocations and negotiations.
2. Hedge funds are necessarily secretive (constantly competing over trades and themes with finite capacity), hard to diligence, and require constant review. Our London & NY research teams speak with all managers quarterly at a minimum and we undertake a full Operational Due Diligence annually, and even with this level of diligence, things change. We’ll unpack hedge fund selection, research and diligence in future pieces, and share some hard learned lessons.

In conclusion, the breadth of hedge fund strategies means that there’s likely to be suitable funds for any market outlook – given our views on market conditions for the remainder of 2024, we’re recommending allocations within the different strategies as mentioned above.