Some hedge funds finally see market conditions to justify their existence

Hedge funds have to adapt to a radically different market environment this year. For some, life has become much harder. But for others, these are precisely the conditions they have been waiting for a long time.

A new world of high inflation, sharply rising interest rates and rapid quantitative tightening, almost unimaginable just a few years ago, has upended stock and bond markets over the past six months. Eurozone inflation this week hit another record 8.1 percentincreasing pressure on the European Central Bank to speed up rate hikes.

High-growth tech stocks have been hit particularly hard. While they can skyrocket to huge valuations when interest rates are close to zero, higher rates mean your potential future earnings look relatively less attractive. Tiger Global and some of the other “Tiger cub” hedge funds that thrived during the bull market have I felt all the force of this liquidation, in some cases losing much more than the market in general.

But for some managers focused on exploiting price discrepancies between stocks, conditions are now in their favor. They had been frustrated by the “all rally” in which investors often seemed unconcerned about whether they were buying a high-quality or low-quality company. However, the removal of ultra-low-cost financing that has long been available to businesses is beginning to separate the wheat from the chaff.

“Market Neutral” [equity] and low net worth funds should benefit from stocks. . . reflecting the fundamentals now,” said Kier Boley, investment director of alternative investment solutions at UBP, referring to funds that try to make money by comparing one stock to another, rather than betting predominantly on rising prices.

A perfect example of how conditions have changed for such funds is London-based Sandbar Asset Management. A year ago I wrote in this column that the company with $2.2 billion in assets, founded by former Millennium trader Michael Cowley, was struggling with the seemingly illogical way the markets operated.

For example, the correlation between an improvement in a company’s earnings expectations and its stock price reaction, which should intuitively be positive, had fallen “to levels not seen in the last decade,” Sandbar said in that report. moment. In some sectors, such as aerospace, it had even turned negative, meaning that improving earnings expectations would actually push share prices lower. Sandbar ended the year down 7.5 percent.

A lot has changed since then. The fund is up 6.7% in the first four months of this year, compared with a 7.3% drop on average for equity hedge funds, according to data group HFR, and a drop of 14 .5% in the S&P 500 index as of Wednesday. .

Significantly, so-called alpha (industry jargon for the money a manager earns through skill rather than simply following general market movements) has been a positive for the fund for each of the last four months.

One of the main reasons, according to Sandbar, is the fact that markets have now entered the “late stages of the business cycle.” He wrote in a letter to investors that historically this has represented a time when conditions have been more favorable for funds like him. This was because the “dispersion [between stocks] rises significantly,” while the returns for simply following the market moderate or turn negative.

Reversal of positions by other investors late last year and early this year as the market fell created opportunities for Sandbar to make a profit in recent months, he added.

While the prospects for such managers have improved markedly, there are still factors that could hinder their progress. Stocks have rallied for the past two weeks on hopes that bad news about the economy will persuade central bankers to limit interest rate hikes. And, as UBP’s Boley points out, even if a manager gets the right analysis of a stock’s fundamentals, his positions can still be sidetracked by a major investor undoing his book.

However, this industry pick, long forecast but often delayed by years of central bank stimulus, is being welcomed by many.

hedge funds have struggled for much of the last decade to justify why investors should pay their high fees when returns were often uninspiring compared to index tracker funds, available at a fraction of the cost, or compared to profits that private equity funds seem to offer.

In a world where stock and bond yields are now less attractive, hedge funds that not only try to ride the markets but exploit market dislocations may finally have met their end.

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