Hedge funds – Cover story
Hedge funds have traditionally promised to give investors an edge. Yet in this uncertain investment environment, the appeal of the asset class has taken another turn – one that potentially offers a great deal more promise. When markets are unpredictable and the macro-economic picture is uncertain, hedge funds tend to offer a defensive investor backstop.
The investment case is also supported by his- tory. This is within the context that for most of the past decade, the hedge fund industry struggled to generate alpha, as low volatility led to fewer trading opportunities while near- zero interest rates hindered the asset price discovery process. But then came the tightening of monetary policies, which have created a macro environ- ment characterised by greater volatility – which should (and the emphasis is on “should”) lead to better investing opportuni- ties for hedge funds. That is to say historically, when equity and fixed income volatility increases, hedge fund alpha generation also improves. This scenario, keen investors will note, occurred last year.
Inflation’s friend So the hedge fund industry has displayed a positive relationship between higher infla- tion and higher interest rate regimes with better hedge fund performance, according to research by Goldman Sachs. Furthermore, during times of low inflation, hedge funds have generated absolute returns that are around half (52%) of those available to equity investors. But in periods of high inflation, hedge funds have materially exceeded US equity market returns, based on the same research. The lessons are clear here, and evident of where we are now. Another factor in favour of hedge funds is the breaking of the traditional stock-bond corre- lation. This has some investors concerned that it will limit the traditional foundations the correlation is built upon, creating an obvi- ous opportunity for hedge funds to fill the gap. Meisan Lim, managing director of hedge fund research at Cambridge Associates, says
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