Investors in hedge funds are seeking out more defensive strategies amid a volatile market environment.
Commodity trading advisors and global macro strategies have seen the largest increases in investor interest over the course of the past year, according to Agecroft Partners, a consulting firm, which released data from a recent survey of investors. Respondents to the survey were asked which types of hedge fund managers they were currently interested in meeting. While almost all hedge fund strategies saw an increase in investor demand from 2021 to 2022, the two strategies with the largest increases in demand were CTAs (up 16 percentage points from 2021) and global macro strategies (up 12 percentage points from 2021 to 2022).
Agecroft attributed the growth in interest for these two strategies to the tumultuous macroeconomic environment, particularly in the first half of 2022. Amid geopolitical uncertainty, volatility, inflation, and rising interest rates, investors have grown increasingly concerned about equity and fixed income markets. They are likely turning to CTAs and global macro strategies due to their typically low or negative correlations to the capital markets: In theory, when markets go down, these strategies go up.
CTAs are liquid strategies that trade financial futures in equity indices, commodities, currencies, and fixed income. Most CTAs are focused on trends and typically focus on “volatility expansion,” which is when volatility increases in the marketplace, according to Don Steinbrugge, chief executive officer and founder of Agecroft Partners.
Because of this focus on volatility, CTAs typically do quite well during market sell-offs. It’s a similar deal with global macro strategies, which manage portfolios based on macro calls in the marketplace across multiple asset classes.
“Right now, there are a lot of investors concerned about both the equity and the fixed income marketplace and think there could be further sell-offs in both markets. They are looking for strategies that help diversify their portfolio that can also do well when those markets sell off,” Steinbrugge told Institutional Investor.
But it may not just be current market anxiety that’s driving the shift to uncorrelated hedge fund strategies. According to the survey, many pension funds have changed their focus from outperforming hedge fund indices to building portfolios of diversifying strategies. As a result, these allocators are increasingly targeting strategies that will protect them from market downturns.
Up until 2008, most pension funds were getting their hedge fund allocations from funds-of-funds, Steinbrugge said. After the financial crisis, an industry-wide trend toward building out hedge fund research capabilities emerged, and public pension plans started building out their own hedge fund portfolios directly.
“When they did that, their portfolios, from a strategy diversification standpoint, looked somewhat similar to hedge fund indices,” Steinbrugge said.
Since then, pension funds have gotten more targeted with their hedge fund portfolios, eliminating strategies that had high correlation to other areas of their overall portfolios. For many funds, this meant moving away from long-bias long-short equity managers or managers with high correlations to fixed income markets, according to Steinbrugge.
For example, public pension plans like the State Retirement and Pension System of Maryland and the World Bank Pension Fund focus on lower correlation strategies and don’t look at longer bias managers, Steinbrugge said.
While the majority of hedge fund strategies saw increased investor interest from 2021 to 2022, two strategies experienced a decline: Interest in emerging markets strategies was down 3 percentage points from 2021, while interest in long-only strategies fell 2 percentage points from last year.
Long-only strategies are considered more risky during periods of market volatility, as they typically perform better when markets are experiencing upward momentum. Meanwhile, emerging markets are typically perceived as holding more inherent risk than developed markets. Investors expect emerging markets to get hit harder by market downturns than developed markets, triggering a decline in demand for emerging market managers, Steinbrugge said.
The strategy with the greatest rate of investor interest was long-short equity at 64 percent, up slightly from 62 percent in 2021. According to Steinbrugge, this signals continued faith in fund managers’ ability to pick alpha-generating stocks.