Inflation, which most economists and central banks still regarded as temporary at the end of last year, is now here to stay. Pressure in commodities and China’s zero-Covid strategy, which is disrupting supply chains and hampering the free flow of trade, suggest that inflation will continue to press upwards and stabilise at levels higher than previously expected, and for longer. In the meantime, equity and bond markets are adapting to the tougher conditions, including a rise in interest rates that has spelt the end of free money. The consequences of the conflict in Ukraine have created more problems for European economies, which are particularly dependent on Russia for their hydrocarbon supplies.
In recent years, unconventional central-bank policies featuring asset purchases have supported markets artificially and encouraged investors to buy risky assets. Now that these loose policies are being replaced with monetary tightening, risky assets are being repriced. The market is also being more selective regarding individual issuers. Struggling companies that used to enjoy favourable borrowing terms are now likely to experience difficulties refinancing.
Macro & systematic strategies in vogue
For investors, this volatile and more discriminating environment is generally more conducive to alternative strategies that show low correlation with broad market movements. For example, macro and particularly macro & systematic strategies fared well in the first two quarters of 2022, with the HFRI Macro: Systematic Diversified index rising 9.67%*. These strategies have been able to generate attractive returns by taking long positions on commodities and short positions on bond and equity markets. Like relative-value strategies, they have proven their defensive worth in turbulent market conditions.
On the downside, equity long/short strategies have suffered so far this year (HFRI Equity Hedge Total down 4.1%*), while credit and event-driven strategies were generally fairly resilient to the harsh market conditions (HFRI Event-Driven index down 1.42%*). However, there are several types of long/short strategies with varying degrees of exposure to equities. Of them, market-neutral strategies are currently the most sought-after. In the medium term, however, we believe that long/short (equity and credit) and macro & systematic strategies could represent opportunities for investors, given the context of monetary tightening that is causing financial assets to be repriced downwards in line with their fundamentals.
Alternative strategies also seek to take advantage of market dislocations. The aim is to capture a series of spread-widening events, without taking any directional position. A good example in the commodities market came in February 2022, when trading in nickel was suspended on the London Metal Exchange (LME) but continued on the Shanghai Futures Exchange (SHFE). This briefly resulted in a market dislocation that provided a real opportunity for investors.
It is vital to seek proper advice before adopting an alternative investment strategy, because alternative asset managers vary widely in quality. Rigorous selection is the key to success in our industry.
*Hedge Fund Research (HFR) Inc. (first quarter of 2022)
Fredrik Langenskiöld