Hedge funds in aggregate have yielded negative year-to-date performance but demonstrated outperformance relative to public markets. Elevated inflation, geopolitical uncertainties, and the rapidly tightening liquidity conditions have brought significant challenges across most asset classes. Over the first four months of the year, only commodities, MSCI Brazil, and the USD have provided investors with substantial positive returns.
The extremely challenging backdrop meant hedge funds, which retain a bias towards positive net exposures to risk, have similarly struggled with absolute performance. Various hedge funds indices have shown that aggregate performance in 1Q22 had been negative. Nevertheless, this represents a relative outperformance to many risky assets such as global equities, including the S&P 500, and the standard 60/40 portfolio. The value proposition of hedge funds to add alpha and better risk-adjusted returns continue to look favourable given the expected shifts in market conditions. Performances to-date have supported our thesis.
Exhibit 1: Hedge funds outperformed global equities and standard 60/40 portfolio this year
*Performance of 60/40 portfolio proxied by the iShares Core Growth Allocation ETF
Source: Bloomberg, Bank of Singapore.
Specific strategies or groups of hedge funds have gone further and generated positive returns this year, adding significant alpha. Macro/directional hedge funds – broadly defined as funds that take directional positions in currencies, bonds, equities, and commodities in a discretionary or systematic fashion – have outperformed strongly relative to other strategies this year (9.7% over January-April based on the HFRI Macro Total Index as of 19 May 2022.)
Global investors continue to direct funds into hedge funds in 1Q22, after the strong inflows witnessed since late 2020 and the full year of 2021. The latest data by HFR showed that 1Q22 was another stellar quarter in terms of flows into hedge funds, despite the challenging market backdrop. Top performing macro strategies, especially commodity trading advisors (CTAs), attracted the most inflows. Relative value also received substantial inflows, as investors look towards this group of managers to navigate the extreme level of interest rates volatility. The largest funds in the industry, i.e. those managing AUM greater than USD5b, received the bulk of the net new capital.
The elevated volatility in markets tends to be a positive backdrop for hedge funds to perform, and more importantly to add value by improving risk-adjusted returns. So far, this has borne out with the relative outperformance, but less so in terms of providing absolute downside protection. The alpha is significant for selected strategies and top-performing managers. We are not asserting that the trades that have worked over the past few months will produce similarly positive outcomes in the coming quarters as markets continue to navigate an uneasy transition to higher rates and slower growth. However, we have seen selected managers adjusting their trades and positions in a nimble fashion in response to the changing market conditions and, in the case for some, thriving in the current environment. Investors with the appropriate time horizon can incorporate a selection of hedge funds to buttress their risk exposures, or as an alternative route to stay invested while staying opportunistic in their core portfolio holdings. In addition to macro strategies, market neutral and relative value strategies with focus on absolute returns can and have provided diversification benefits and less correlated returns.Disclaimer applicable to recommendation
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