After Recording Worst Year Since 2008, Hedge Funds Now Brace for a Difficult 2023

Last year, global hedge funds recorded the worst returns in 14 years after the Federal Reserve’s extremely tight monetary policy weighed on asset prices. On a more positive note, the funds’ losses were smaller compared to the substantial declines in equity and bond markets during the year.

Data showed that some hedge funds employed macro-oriented strategies, such as investing in commodities and currencies, while taking advantage of price discrepancies between related securities.

Negative Returns but Still Better Than Stocks, Bonds

Investment data firm Preqin said global hedge fund returns fell by 6.5% in 2022, marking the biggest decline since 2008, when returns plummeted 13%. For comparison, the MSCI World Index, a broad global equity index that tracks the performance of large and mid-cap equities across 23 developed countries, fell by 18.7% in 2022. In contrast, the ICE BofA U.S. Treasury index lost almost 12%. The S&P 500 closed the year nearly 20% lower.

When it comes to strategies, macro funds gained 8.2% from the start of 2022 through November, compared to equity-hedged and event-driven strategies, which plunged 9.7% and 4.7%, respectively, as per Hedge Fund Research (HFR) data.

UBS strategists wrote:

“As a strategy, macro has historically been less correlated to movements in the broader stock market, helping to diversify portfolios. We think a continuation of tight monetary policy and high volatility should prove favorable for macro managers in 2023.”

In addition, activist funds declined by 13.8%, according to HFR. These types of hedge funds leverage minority stakes to fight for strategy and management changes to increase shareholder value.

Janus Henderson Investors’ Andrew Hendry said trend-following strategies delivered decent returns in 2022 thanks to strong inflationary pressures. These strategies are based on the idea that markets factor in information “inefficiently and at different speeds,” and markets that start moving in one direction are unlikely to see a trend reversal, he added.

“The trend has had a great 2022 with things like strong commodity prices and weak bonds contributing substantially to performance,” said Hendry.

According to Preqin, net assets belonging to global hedge funds dropped 4.8% in the first three quarters of 2022 to $4.3 trillion. These funds saw $109.8 billion in total outflows during that spell. In addition, only 915 funds were launched during 2022, the lowest in 10 years.

Another Difficult Year in 2023?

Following a tumultuous 2022, a great number of global hedge fund managers are bracing for another year of high inflation, improving the appeal of commodities and bonds that tend to perform well in such conditions.

Most of the ten global asset and hedge fund managers believe that commodities are currently undervalued and are likely to thrive this year amid expectations that inflation will remain elevated in 2023. Other assets that could perform this year include inflation-linked bonds, which serve as a hedge against price increases and exposure to corporate credit.

On the flip side, fund managers will likely avoid or short-sell the equity market, which came under significant pressure as the Fed continued to tighten its monetary policy throughout 2022. Additionally, many companies could see further earnings damage in 2023.

Jordan Brooks, co-head of macro strategy at AQR Capital Management, said it is unlikely that 2023 will bring lower interest rates, disinflation, and strong earnings all at once. He added that such a scenario is overly optimistic, which is why he recommends a risk-parity investment strategy that focuses on the allocation of risk across assets like stocks, commodities, and bonds.

Another hedge fund manager, Crispin Odey, shares his peers’ views that inflationary pressures will persist into 2023. Odey yielded significant returns in 2022 from shorting U.K. government bonds, ending the year up around 145%. On the other hand, Odey trimmed his short position in gilts but remained long on inflation-linked gilts. He also believes that commodities are likely to rise again this year after seeing a massive sell-off.

The majority of hedge fund managers think that long-short equity investment strategies will continue to underperform in 2023, while macro-focused approaches that take advantage of volatility and can long or short any asset are likely to retain their strong performance.

Blackstone Alternative Asset Management global head Joe Dowling said this is “the perfect environment for macro hedge funds” as the divergence between central bank policies, interest rate differences, and geopolitical tensions create a lot of opportunities for investors focused on exploiting volatility.

Abrdn’s hedge fund solutions’ Kevin Lyons expects a soft global recession in the following year and thinks that companies with a strong balance sheet are likely “trading at a wider spread than what they were three years ago.”

Summary

Hedge funds recorded the worst returns since the Global Financial Crisis (GFC) last year as the Fed’s aggressive monetary policy tightening in order to curb inflation resulted in an extremely challenging year for investors. Money managers are now bracing for another challenging year after the Fed committed to staying aggressive until the data shows inflation is moving towards substantially lower levels.

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Shane Neagle is the EIC of The Tokenist. Check out The Tokenist’s free newsletter, Five Minute Finance, for weekly analysis of the biggest trends in finance and technology.