Hedge funds haven’t had a great run over the past several years — but one liquid alternatives manager thinks that is about to change.
After a decade of outperformance by passive investors, markets may soon favor nimble, active strategies like hedge funds, according to Andrew Beer, managing member of Dynamic Beta investments, a liquid alts boutique that’s part-owned by iM Global Partner.
In a blog post proclaiming that “Hedge Funds Are Back!,” Beer argued that market conditions today look more like the start of the 2000s — the hedge fund industry’s “golden years” — than the “lost years” of the 2010s, when hedge funds returned only 4 percent annualized.
A simple passive portfolio of stocks and bonds, by contrast, gained almost 7 percent per annum during the 2010s, Beer said.
“This was a brutal decade for active management overall,” he wrote. “Under-loved value stocks suffered historic underperformance and many strategies were hammered by a market seemingly divorced from fundamentals.”
Now, however, Beer argues that years of low interest rates and climbing equity valuations may have brought markets to an inflection point, where “overlooked or forsaken” investments like value stocks and emerging markets could start to outperform again.
“The S&P currently trades at 33 times earning and a high percentage of U.S. equity value rests in a handful of stocks with nosebleed valuations,” Beer wrote. “On the fixed income front, Treasury yields are alarmingly close to zero and corporate credit appears to be in a bubble.”
“The 2020s may well be a ‘lost decade’ for simple, passive portfolios,” he added.
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According to Beer, hedge funds are best positioned to take advantage of the changing market conditions, because hedge funds managers can shift into the right markets at the right time.
“The true competitive advantage of hedge funds may be their flexibility,” Beer argued. “A U.S. large-cap equity manager must still buy those stocks even at sky-high prices; pension funds might tilt their portfolios by a few percent, but no more. Research on hedge funds shows that they will change, and change in a big way, as market conditions evolve.”
Still, Beer admits that there are some potential landmines for hedge fund investors in the 2020s. The concentration of capital among the largest hedge fund managers, for example, means that these managers may not be as nimble as the hedge funds of the 2000s. Similarly, hedge funds with institutional investors may be limited in how much they can veer from their original strategies.
There’s also what Beer calls the biggest headwind for hedge fund performance: “too high” fees.
Despite these obstacles, Beer argues that hedge funds will be able to deliver value over the coming years, thanks to a “compelling” opportunity set and the expected weakness of passive investments.
“The 2020s, then, might well be a Second Golden Age,” he said.