Report: Hedge Funds Due for a Comeback

Hedge funds and private equity managers will get more opportunities to outperform now that central banks around the world have started to normalize their monetary policies, according to strategists J.P. Morgan Asset Management.

Released today, JPMAM’s 2018 Long-Term Capital Market Assumptions, the latest iteration of its annual market outlook, evaluates the structural factors that will affect economies and asset returns over the next ten to 15 years. The report notes that with central banks buying bonds and other securities for years to keep interest rates low, global assets have been rising in lockstep — and hedge funds and others have had fewer opportunities to distinguish themselves with winning picks.

But now that central banks are starting to pull back from that strategy, securities and sectors will theoretically rise and fall based on fundamental characteristics, the report’s authors said.

“With lower correlations across individual stocks and indices, there is more room for managers to play,” said John Bilton, head of global multi-asset strategy, at a media event at the firm’s New York headquarters to discuss the new report.

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Still, Bilton emphasized that manager selection is particularly important when it comes to alternative investments and can add a significant amount of outperformance. For example, the median private equity manager is expected to return 7.25 percent, according to JPMAM, whereas those in the top quartile will return in the mid-teen range.

“The message we have for clients is that active asset allocation is important, but so too is selecting the right manager,” said Bilton.

Hedge funds will benefit more from the change in monetary policy, the report finds.

“The improvement in alpha opportunities, though, is more pronounced in the hedge fund sector, where the shift from a macro-driven to a more fundamentally driven investing environment is supportive,” according to JPMAM’s capital market assumptions. “Improved alpha opportunities and worsening beta underline our view that manager selection remains the critical driver of returns.”

JPMAM thinks the outlook for real assets is relatively attractive, even though valuations are high. Since the financial crisis, market participants have demonstrated discipline with their strategies, including their use of leverage, particularly with real estate, the JPMAM report said.

International diversification will pay off for investors in the coming years, added Maddi Dessner, a client portfolio manager on the multi-asset solutions team.

“For five years it’s been tough to talk to clients about international diversification,” she said. “But global investors will benefit from the weakness in the dollar and the increase in growth expectations in the euro zone.”

The JPMAM strategists noted that the current economic expansion is in its ninth year, and the bull market in fixed income is in its 37th year. As a result, among other asset return expectations, JPMAM has lowered its assumption for U.S. large-cap equities from 6.25 percent last year to 5.5 percent this year.