The only thing certain is uncertainty
Faced with the current unpredictability, hedge funds are regaining their protective role
To paraphrase Socrates, the financial markets have long convinced us that there is little certainty in investing. Today, with the war that has just broken out in Europe, the spectre of inflation, the long-awaited but dreaded normalisation of monetary policy, the (hopefully) final stirrings of the pandemic, not to mention the urgency of the energy transition and the bottlenecks in supply chains, everything seems to presage the end of the long period of good times that investors have experienced.
The end of easy money
It must be said that for more than 12 years, they have had it easy. Indeed, driven by the prolonged decline in interest rates over the past 40 years, bond markets have delivered spectacular returns. At the same time, the stock markets have reached unprecedented highs, with just a few antics to remind us that they are officially risky assets. Everyone was able to think of themselves as an expert who turns everything they touch into gold. But everyone knows that the story ends badly for King Midas, and it is feared that many market players, who have only known this golden period, will soon face a cruel reality check. Investors seem to feel that a sword of Damocles threatens them because, for the past few months, nervousness has returned, as shown by the violent price drops that occur as soon as a company publishes results that are even slightly below consensus, as was the case for John Deere or Amazon.
The deck is being reshuffled
Faced with this situation, the strategies that had been abandoned during the explosion of growth stocks and the supremacy of indexed management are coming back to the fore. Thus, global macro strategies, which had hardly shone in 2021, led the way in January with increases of between +4% and +5%, taking advantage of the prevailing volatility to show what they were capable of. They have handily outperformed the NASDAQ, which has lost nearly 9.5%, and the more directional alternative strategies. Similarly, we are currently witnessing a real comeback for value stocks at the expense of growth stocks, which had been the big winners of the pandemic and especially of the last decade. In fact, after 10 years of having to settle for second place, value stocks have significantly outperformed the growth segment, both in the US and in Europe, with a 10 percentage point difference since the beginning of the year.
Active management back in the spotlight
It must be said that active managers, both in long-only and alternative strategies, are by definition flexible and can adapt quickly. Free from the constraints of indexes, they can respond quickly to changing situations. Moreover, the range of alternative strategies is so wide that there are always opportunities to find managers who can take advantage of current conditions. This is of course the case for global macro funds, which in essence make extensive use of option strategies and often have a convex “long volatility” profile. After a lean decade, the rise in interest rates and the turnaround in market conditions could even give a boost to market-neutral managers, who are able to benefit from the high intra-sectoral dispersion. In 2022, it will therefore probably be necessary to react quickly, and sector choices will prove to be crucial.
The return of value investing
As we’ve seen, the value style is coming back in a big way, as with Paul Marshall, the star manager of the Eureka fund at the renowned Marshall Wace firm, who for the first time since 2011 now has a net “long” position in value stocks and a “short” position in growth stocks. Managers will therefore have to go back to analysing companies and balance sheets to find poorly valued companies. However, there are fewer and fewer financial analysts in brokerage houses and investment banks. On Wall Street alone, there is an average of 24% fewer analysts since 2013. Companies are therefore less well covered – a trend that is even more pronounced for smaller stocks – which makes the market less efficient and thus generates more opportunities for value managers.
The end of the 60/40?
What are the consequences for asset allocation? First, it is clear that the classic 60/40 portfolio model of 60% equities and 40% bonds, which has performed well over the past 10 years, is in for a rough ride over the next 3-5 years. Due to the expected rise in interest rates, bond investments appear to be unattractive, with price declines to be expected. Moreover, equity markets seem to be overvalued and are likely to be more volatile in the future. Under these conditions, alternative strategies deserve to regain the allocations they had until 2008. First of all, through relative value strategies, which are an interesting alternative to fixed-income because of their regular performance, low volatility and, above all, their decorrelation from the markets. Secondly, for the equity portion, via more active, value-oriented management strategies that seem more suited to the current environment, as well as opportunistic, global macro-type alternative funds.
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