For years, the climate for hedge funds was tough. Volatility was low. The price of everything was going up. It wasn't that hard to make money. In that type of environment, why think outside the box?
But as central banks continue with their aggressive campaign of interest rate hikes aimed at bringing down inflation, sending markets on a rollercoaster ride, alternative strategies are getting another look.
"Certain hedge fund strategies can perform well in volatile and sideways-moving markets, an environment we expect to last into next year," Mark Haefele, chief investment officer at UBS Global Wealth Management, told clients on Tuesday.
On the heels of a summertime rally, markets have started to churn again. Concerns have ramped up ahead of the Federal Reserve meeting on Tuesday and Wednesday, at which the only debate will be over how much to hike rates.
The S&P 500 just logged its worst week since June. Government bonds are also experiencing a steep sell-off. The yield on the benchmark 10-year US Treasury, which moves opposite prices, reached its highest in more than a decade on Monday.
No matter what the Fed announces tomorrow, uncertainty is likely to linger, given the central bank's emphasis that it intends to keep making decisions on a meeting-by-meeting basis.
"Volatility is going to be the dominant theme through the back half of the year, largely because central banks remain data dependent," Laura Cooper, senior macro investment strategist at BlackRock, told me.
That's boosting interest in hedge funds, through which professional investors try to beat the market by deploying less-conventional approaches.
These funds struggled in the wake of the global financial crisis. Low interest rates and a period of relative calm in markets limited opportunities for contrarians. Now, they have an opening again — and some are finding success.
Hedge fund performance improved in August even as the stock market fell, according to the latest reading of the HFRI 500 Fund Weighted Composite Index, which tracks the top funds in the industry.
Not all types of funds are created equal. One standout has been macro funds, which look to take advantage of political and economic volatility. That category is up 14.8% year-to-date, while the S&P 500 fell 17% through August.
Investors trying to capitalize on turmoil in commodity markets have done particularly well, according to Robert Sears, chief investment officer at Capital Generation Partners, which invests in hedge funds for wealthy families.
Additionally, there are opportunities for stock picking, with some companies set up better to weather high inflation and an economic downturn. In recent days, warnings from companies including Ford and FedEx have sparked concerns that a wave of earnings downgrades could loom.
"Until we get into the cycle of earnings going down and the Federal Reserve starting to ease policy, really you're set for an environment when hedge funds should do quite well," Sears told me.
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