With Volatility Spiking, Allocators Swap Stocks and Bonds for Hedge Funds

After enjoying a solid year of returns in 2021, allocators appear ready to head back to the hedge-fund well in 2022.

French bank BNP Paribas, which surveyed 224 allocators representing $1.2 trillion in hedge fund assets, said in a report Wednesday that investors are expected to have met their average return target of 8.3 percent for their 2021 hedge fund portfolios. The report noted that 62 percent of all participants had already met this target by the end of November, including 29 percent who had exceeded it by that time.

Sixty-five percent of the survey respondents are based in the United States, 29 percent are based in Europe, the Middle East, and Africa, and the rest are based in Asia. They include institutional investors such as pensions, endowments, and foundations, as well as intermediaries such as funds of funds, outsourced chief investment officers, and investment consultants.

With a year of strong returns behind them, hedge funds could be a better investment choice for institutional investors than private credit or real assets, which were at the center of allocators’ alternative portfolios just a few years ago. According to BNP, more than half of the allocators surveyed plan to increase their hedge fund allocations by an average of $244 million in 2022, signaling a shift away from long-only funds across equity, credit, and fixed-income. 

Hedge funds, especially those that focus on low-beta strategies, could offer great protection against rising inflation and other volatility-triggering events. By definition, low-beta portfolios have a very low correlation to the public markets, an important advantage that hedge funds can offer allocators during heightened market volatility, according to Marlin Naidoo, global head of capital introduction and consulting at BNP.

“Investors are increasing their allocations to low-beta hedge funds that can achieve high-single-digit returns,” said Naidoo. He added that many multistrategy funds, which invest across the equity, fixed-income, quant, and fundamental sectors, “strive to find low beta.” BNP Paribas predicts that multistrategy funds will outperform in 2022, after trailing event-driven strategy funds in 2021.

Naidoo noted that the recent market turmoil spurred by the Russia-Ukraine conflict is unlikely to change investor confidence in hedge funds. “Firms have spent the last two years dealing with a lot of unforeseen issues,” he said, citing Covid and the operational disruptions it brought to the economy. “What we saw in the hedge fund world in the past two years was people trying to ensure that their portfolios were the bellwether,” he added. For this reason, investors already expect low-beta strategies to help them “navigate these difficult and volatile times as we head into 2022.”

One of the main challenges facing hedge fund investors this year, Naidoo said, is to “be able to pay the right – perhaps higher – fees for the funds they want to add to the portfolio, after years spent reducing their overall hedge fund fees.” Certain types of managers will quickly meet their capacity limit, he explained, so allocators need to deploy capital before these funds close.