Insight Article Desktop Banner
 
 
2022 Outlook
  •  
enero 13, 2022

Hedge Funds in 2022: Changing With Changing Risk

Insight Video Mobile Banner
 
enero 13, 2022

Hedge Funds in 2022: Changing With Changing Risk


2022 Outlook

Hedge Funds in 2022: Changing With Changing Risk

Share Icon

enero 13, 2022

 
 

In 2022, we believe the most notable trends will be the continuation of ones that gathered strength in 2021: Higher volatility levels in both the equity and fixed income markets leading to wider dispersion in performance of stocks, bonds and off-the-run investment opportunities. The main volatility drivers were—and continue to be— the triumvirate of headlines that became all-too-familiar: Tightening of monetary policy by the U.S. Federal Reserve, increasing inflation, and the uncontrolled growing spread of COVID-19. Hedge funds performed well through this volatility (Display 1).

 
 
 
DISPLAY 1 Hedge funds had solid performance in 2021.
 

Source: HFR, Inc., as of November 30, 2021.

 
 

Risk management seen as key to hedge fund success in 2022

In contrast, risk markets in prior years were mostly driven by accommodative Fed policy and fiscal stimulus, creating an ideal environment that lifted all boats and beta returns. Hedge funds, which limit market risks and seek to generate alpha, underperformed.

But rising volatility and performance dispersion create a fertile field for hedge fund managers, who found their footing again in 2021, as shown by alpha production in Display 2. The rolling two-year average annualized alpha has been positive all year and is the highest it has been since January 2018. One needs to go back to August 2011 to find prior periods of such strong and consistent alpha production.

 
 
 
DISPLAY 2 Hedge fund managers have generated alpha consistently for the past two years.
 

Source: HFR, Inc., as of November 30, 2021.

 
 

The changing nature of risk

We believe that the biggest challenge to hedge funds in 2022 will be the changing nature of market risk. Hedging unwanted market exposure has always been key to protecting alpha, but doing so has become more complicated and nuanced.

For example, the impact of “risk on/ risk off” episodes has typically been effectively hedged with the S&P 500 Index, largely because factors like growth, momentum and value have had reasonably consistent—and predictable— performance during such periods.

But the same has not held for “COVID on/COVID off” episodes. Investors have had to rapidly switch between the prospects of the economy opening up and shutting down, and the related impacts on stocks from labor shortages, supply chain dynamics and so forth. Performance factors underwent large shifts in direction and magnitude, and as a result, the S&P 500 became too blunt a tool for hedging in that environment. Factor exposures associated with hedge funds have been behaving very differently than the market, as can be seen in the last few days of November 2021 (Display 3).

 
 
 
DISPLAY 3 In “COVID on/COVID off” episodes, factor exposures behaved very differently than the S&P 500.
 

Past returns are not indicative of future results. Source: Barra (US Barra Medium Term Model)

 
 

The Omicron scare

We saw the impact of this in the wake of the Omicron scare of November 2021, when managers with good security selection lagged the quick rebound in the S&P 500. For effective risk management, managers have to know how a basket of principal factor risks maps onto their portfolios. Many clearly didn’t have a refined understanding of this “map” in the evolving COVID on/COVID off world, which likely led to overhedging or other uneven factor exposures.

Another clue comes from the relative performance of classic long/short managers in comparison with multi-portfolio manager platforms. We believe that the multi-PM platforms generally can have a structural advantage for risk management.

Assuming the platforms devote sufficient resources and expertise to that function, they potentially can manage risk across more dimensions and continually develop the map connecting factors to positions. Even after accounting for their higher-cost pass-through structure, the after-fee results of the Platform Peer Group (Display 4) and their respective investment profile compare favorably.

 
 
 
DISPLAY 4 Multi-PM platforms have outperformed classic long/short hedge funds.
 

Sources: HFR, Inc., Morgan Stanley. From December 31, 2016 to November 30, 2021.

 
 

COVID is hardly the only likely source of volatility in 2022. The Fed’s tapering is potentially a major source, given the conflicting currents the central bank may have to navigate, with inflation prints coming in over 6% and the 10-year U.S. Treasury around 1.5% as of December 2021. An accelerated tightening policy could slow growth, especially if there is a parallel drag from COVID developments, and no one—including the Fed—really knows the optimal rate level for slowing inflation without harming the recovery.

The economy has been shaped by super-easy money for a long time. Even an increase of 75 basis points in 2022, as contemplated by the Fed, is a big adjustment, and it is a big leap of faith to assume it will be a smooth one.

Implications for 2022

Our outlook for more volatility and dispersion in performance for 2022 has a number of implications:

  • SECURITY SELECTION is likely to play a larger role in alpha generation, given the expected start/stop nature of the markets and related choppiness that is likely to disrupt sector trends and broader thematic investing. By the same logic, the intrasector opportunity set looks promising as a source of idiosyncratic return independent of  COVID on/COVID off, inflation or other macro influences. As noted earlier, long/short strategies that are supported tightly by risk management, tend to preserve alpha better (Display 4).
  • DIVERSIFICATION OF ALPHA SOURCES becomes especially important because dispersion is a double-edged sword that increases both the number of opportunities and the chance of bad calls. Controlling intermanager correlations is critical—it ensures risks do not overlap and helps minimize losses from bad calls.
  • PROMISING STRATEGIES for us include global macro, with managers agile enough to capture the value of the cross currents in today’s environment, with a short-term, tactically oriented approach.
    Select commodity strategies fall in this category, such as taking advantage of quick-shifting currents in supply and demand in metals, livestock and agricultural markets, or even relative value trading in the oil markets between West Texas Intermediate and Brent Crude. However, pure price moves are only part of the story, as specialists can also maximize calendar spreads, contract rolls and physical delivery features.
    Less appealing strategies include long-bias credit risk, where spreads are at historically tight levels, and mortgage arbitrage—a sector hindered by a limited upside and the fact that duration typically lengthens as rates rise.
  • USING HEDGE FUNDS AS DIVERSIFIERS in classic 60/40 stock/bond portfolios can help address a fundamental problem with bonds in 2022: Most fixed-income sectors are long duration. For example, with a duration of 6.6 years, the Bloomberg Aggregate Index would lose over 6% of its value with each 1% increase in rates, and would be unlikely to provide much of a hedge for equities in that scenario. As absolute-return vehicles, hedge funds typically have a low beta to equities and rates, and thus may be an attractive hedge complement for bonds in 2022.
  • CRISIS RISK OFFSET STRATEGIES deserve consideration by investors seeking protection from tail risk events. Such hedging strategies seek to deliver positive returns during loss scenarios while reducing outright costs in normal markets. They can also provide the requisite diversification needed to allow for continued exposure to desired risks. Some risk offset programs are designed to even provide liquidity during times of significant market crisis.
     

Changing with changing risk

The volatility and dispersion of returns we expect in 2022 suggest that security selection will be a key driver of returns. But this environment will demand more from managers. We believe success will also require sophisticated portfolio construction, supported by a nuanced understanding of hedging as factor exposures change in the COVID on/ COVID off world. In our view, investors would benefit from considering hedge funds constructed with diversified alpha sources and a strong risk management process.

 
mark.van.der.zwan
Chief Investment Officer and Head of AIP Hedge Fund Solutions
 
 
 
 

DEFINITIONS

HFRI Equity Hedge (Total) Index: Investment Managers who maintain positions both long and short in primarily equity and equity derivative securities. A wide variety of investment processes can be employed to arrive at an investment decision, including both quantitative and fundamental techniques; strategies can be broadly diversified or narrowly focused on specific sectors and can range broadly in terms of levels of net exposure, leverage employed, holding period, concentrations of market capitalizations and valuation ranges of typical portfolios. EH managers would typically maintain at least 50% exposure to, and may in some cases be entirely invested in, equities, both long and short.

HFRI Event-Driven (Total) Index: Investment Managers who maintain positions in companies currently or prospectively involved in corporate transactions of a wide variety including but not limited to mergers, restructurings, financial distress, tender offers, shareholder buybacks, debt exchanges, security issuance or other capital structure adjustments. Security types can range from most senior in the capital structure to most junior or subordinated, and frequently involve additional derivative securities. Event Driven exposure includes a combination of sensitivities to equity markets, credit markets and idiosyncratic, company specific developments. Investment theses are typically predicated on fundamental characteristics (as opposed to quantitative), with the realization of the thesis predicated on a specific development exogenous to the existing capital structure.

HFRI Fund Weighted Composite Index (“HFRI Fund Weighted”): The HFRI Fund Weighted Index is a global, equal-weighted index of single-manager funds that report to HFR Database. Constituent funds report monthly net of all fees performance in USD and have a minimum of $50 million under management or $10 Million under management and a twelve-month track record.

HFRI Macro (Total) Index: Refers to the HFRI Macro (Total) Index, sponsored by Hedge Fund Research, Inc. Macro funds trade a broad range of strategies in which the investment process is predicated on movements in underlying economic variables and the impact these have on equity, fixed income, hard currency and commodity markets.

HFRI Relative Value (Total) Index: Investment Managers who maintain positions in which the investment thesis is predicated on realization of a valuation discrepancy in the relationship between multiple securities. Managers employ a variety of fundamental and quantitative techniques to establish investment theses, and security types range broadly across equity, fixed income, derivative or other security types. Fixed income strategies are typically quantitatively driven to measure the existing relationship between instruments and, in some cases, identify attractive positions in which the risk adjusted spread between these instruments represents an attractive opportunity for the investment manager. RV position may be involved in corporate transactions also, but as opposed to ED exposures, the investment thesis is predicated on realization of a pricing discrepancy between related securities, as opposed to the outcome of the corporate transaction.

Sharpe Ratio: a risk-adjusted measure developed by William F. Sharpe, calculated by dividing the Fund’s excess return relative to the risk-free rate (defined as the rate of return of the Citi Three-Month U.S. Treasury Bill Index) by the standard deviation of the Fund’s return.

Volatility: A statistical measure of the tendency of a market or security to rise or fall sharply within a period of time – usually measured by standard deviation.

Alpha: The excess return of an asset not explained by systemic (market) risk.

Beta: Represents the Fund’s volatility relative to the market. A statistical measure of the tendency of a market or security to rise or fall sharply within a period of time, usually measured by standard deviation. Higher levels of volatility correspond with higher levels of risk. See also Standard Deviation.

RISK CONSIDERATIONS

Investing entails risks and there can be no assurance that any strategy will achieve profits or avoid incurring losses.

Persons considering an alternative investment should refer to the specific fund’s offering documentation, which will fully describe the specific risks and considerations associated with a specific alternative investment.

Morgan Stanley AIP GP LP, its affiliates and their respective directors, officers, employees, members, general and limited partners, sponsors, trustees, managers, agents, advisors, representatives, heirs, successors and executors shall have no liability whatsoever in connection with any person’s or entity’s receipt, use of or reliance upon any information in this piece or in connection with any such information’s actual or purported accuracy, completeness, fairness, reliability or suitability.

Alternative investments are speculative and include a high degree of risk. Investors could lose all, or a substantial amount of, their investment. Alternative investments are suitable only for long-term investors willing to forgo liquidity and put capital at risk for an indefinite period of time. Alternative investments are typically highly illiquid—there is no secondary market for private funds, and there may be restrictions on redemptions or the assignment or other transfer of investments in private funds. Alternative investments often engage in leverage and other speculative practices that may increase volatility and risk of loss. Alternative investments typically have higher fees and expenses than other investment vehicles, and such fees and expenses will lower returns achieved by investors.

IMPORTANT INFORMATION

There is no guarantee that any investment strategy will work under all market conditions, and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market.

A separately managed account may not be appropriate for all investors. Separate accounts managed according to the particular Strategy may include securities that may not necessarily track the performance of a particular index. A minimum asset level is required.

For important information about the investment managers, please refer to Form ADV Part 2.

The views and opinions and/or analysis expressed are those of the author or the investment team as of the date of preparation of this material and are subject to change at any time without notice due to market or economic conditions and may not necessarily come to pass. Furthermore, the views will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date of publication. The views expressed do not reflect the opinions of all investment personnel at Morgan Stanley Investment Management (MSIM) and its subsidiaries and affiliates (collectively “the Firm”), and may not be reflected in all the strategies and products that the Firm offers.

Forecasts and/or estimates provided herein are subject to change and may not actually come to pass. Information regarding expected market returns and market outlooks is based on the research, analysis and opinions of the authors or the investment team. These conclusions are speculative in nature, may not come to pass and are not intended to predict the future performance of any specific strategy or product the Firm offers. Future results may differ significantly depending on factors such as changes in securities or financial markets or general economic conditions.

This material has been prepared on the basis of publicly available information, internally developed data and other third-party sources believed to be reliable. However, no assurances are provided regarding the reliability of such information and the Firm has not sought to independently verify information taken from public and third-party sources.

This material is a general communication, which is not impartial and all information provided has been prepared solely for informational and educational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The information herein has not been based on a consideration of any individual investor circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.

Charts and graphs provided herein are for illustrative purposes only. Past performance is no guarantee of future results.

The indexes are unmanaged and do not include any expenses, fees or sales charges. It is not possible to invest directly in an index. Any index referred to herein is the intellectual property (including registered trademarks) of the applicable licensor. Any product based on an index is in no way sponsored, endorsed, sold or promoted by the applicable licensor and it shall not have any liability with respect thereto.

This material is not a product of Morgan Stanley’s Research Department and should not be regarded as a research material or a recommendation.

The Firm has not authorised financial intermediaries to use and to distribute this material, unless such use and distribution is made in accordance with applicable law and regulation. Additionally, financial intermediaries are required to satisfy themselves that the information in this material is appropriate for any person to whom they provide this material in view of that person’s circumstances and purpose. The Firm shall not be liable for, and accepts no liability for, the use or misuse of this material by any such financial intermediary.

This material may be translated into other languages. Where such a translation is made this English version remains definitive. If there are any discrepancies between the English version and any version of this material in another language, the English version shall prevail.

The whole or any part of this material may not be directly or indirectly reproduced, copied, modified, used to create a derivative work, performed, displayed, published, posted, licensed, framed, distributed or transmitted or any of its contents disclosed to third parties without the Firm’s express written consent. This material may not be linked to unless such hyperlink is for personal and non-commercial use. All information contained herein is proprietary and is protected under copyright and other applicable law.

Eaton Vance is part of Morgan Stanley Investment Management. Morgan Stanley Investment Management is the asset management division of Morgan Stanley.

DISTRIBUTION

This material is only intended for and will only be distributed to persons resident in jurisdictions where such distribution or availability would not be contrary to local laws or regulations.

MSIM, the asset management division of Morgan Stanley (NYSE: MS), and its affiliates have arrangements in place to market each other’s products and services. Each MSIM affiliate is regulated as appropriate in the jurisdiction it operates. MSIM’s affiliates are: Eaton Vance Management (International) Limited, Eaton Vance Advisers International Ltd, Calvert Research and Management, Eaton Vance Management, Parametric Portfolio Associates LLC, Atlanta Capital Management LLC, Eaton Vance Management International (Asia) Pte. Ltd.

This material has been issued by any one or more of the following entities:

EMEA:

This material is for Professional Clients/Accredited Investors only.

In the EU, MSIM and Eaton Vance materials are issued by MSIM Fund Management (Ireland) Limited (“FMIL”). FMIL is regulated by the Central Bank of Ireland and is incorporated in Ireland as a private company limited by shares with company registration number 616661 and has its registered address at The Observatory, 7-11 Sir John Rogerson’s Quay, Dublin 2, D02 VC42, Ireland.

Outside the EU, MSIM materials are issued by Morgan Stanley Investment Management Limited (MSIM Ltd) is authorised and regulated by the Financial Conduct Authority. Registered in England. Registered No. 1981121. Registered Office: 25 Cabot Square, Canary Wharf, London E14 4QA.

In Switzerland, MSIM materials are issued by Morgan Stanley & Co. International plc, London (Zurich Branch) Authorised and regulated by the Eidgenössische Finanzmarktaufsicht (“FINMA”). Registered Office: Beethovenstrasse 33, 8002 Zurich, Switzerland.

Outside the US and EU, Eaton Vance materials are issued by Eaton Vance Management (International) Limited (“EVMI”) 125 Old Broad Street, London, EC2N 1AR, UK, which is authorised and regulated in the United Kingdom by the Financial Conduct Authority.

Italy: MSIM FMIL (Milan Branch), (Sede Secondaria di Milano) Palazzo Serbelloni Corso Venezia, 16 20121 Milano, Italy. The Netherlands: MSIM FMIL (Amsterdam Branch), Rembrandt Tower, 11th Floor Amstelplein 1 1096HA, Netherlands. France: MSIM FMIL (Paris Branch), 61 rue de Monceau 75008 Paris, France. Spain: MSIM FMIL (Madrid Branch), Calle Serrano 55, 28006, Madrid, Spain.

MIDDLE EAST

Dubai: MSIM Ltd (Representative Office, Unit Precinct 3-7th Floor-Unit 701 and 702, Level 7, Gate Precinct Building 3, Dubai International Financial Centre, Dubai, 506501, United Arab Emirates. Telephone: +97 (0)14 709 7158).

EVMI utilises a third-party organisation in the Middle East, Wise Capital (Middle East) Limited (“Wise Capital”), to promote the investment capabilities of Eaton Vance to institutional investors. For these services, Wise Capital is paid a fee based upon the assets that Eaton Vance provides investment advice to following these introductions.

U.S.

A separately managed account may not be appropriate for all investors. Separate accounts managed according to the Strategy include a number of securities and will not necessarily track the performance of any index. Please consider the investment objectives, risks and fees of the Strategy carefully before investing. A minimum asset level is required. For important information about the investment managers, please refer to Form ADV Part 2.

Please consider the investment objectives, risks, charges and expenses of the funds carefully before investing. The prospectuses contain this and other information about the funds. To obtain a prospectus for the Morgan Stanley funds please download one at morganstanley.com/im or call 1-800-548-7786 for the Eaton Vance and Calvert Funds please download one at https://funds. eatonvance.com/open-end-mutual-fund-documents.php or contact your financial professional. Please read the prospectus carefully before investing.

Morgan Stanley Distribution, Inc. serves as the distributor for Morgan Stanley Funds.

Eaton Vance Distributors, Inc. (“EVD”), serves as the distributor for Eaton Vance and Calvert Funds.

NOT FDIC INSURED | OFFER NO BANK GUARANTEE | MAY LOSE VALUE | NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY | NOT A DEPOSIT

Hong Kong: This material has been issued by Morgan Stanley Asia Limited for use in Hong Kong and shall only be made available to “professional investors” as defined under the Securities and Futures Ordinance of Hong Kong (Cap 571). The contents of this material have not been reviewed nor approved by any regulatory authority including the Securities and Futures Commission in Hong Kong. Accordingly, save where an exemption is available under the relevant law, this material shall not be issued, circulated, distributed, directed at, or made available to, the public in Hong Kong. Singapore: This material should not be considered to be the subject of an invitation for subscription or purchase, whether directly or indirectly, to the public or any member of the public in Singapore other than (i) to an institutional investor under section 304 of the Securities and Futures Act, Chapter 289 of Singapore (“SFA”); (ii) to a “relevant person” (which includes an accredited investor) pursuant to section 305 of the SFA, and such distribution is in accordance with the conditions specified in section 305 of the SFA; or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. This publication has not been reviewed by the Monetary Authority of Singapore. Eaton Vance Management International (Asia) Pte. Ltd. (“EVMIA”) holds a Capital Markets Licence under the Securities and Futures Act of Singapore (“SFA”) to conduct, among others, fund management, is an exempt Financial Adviser pursuant to the Financial Adviser Act Section 23(1)(d) and is regulated by the Monetary Authority of Singapore (“MAS”). Eaton Vance Management, Eaton Vance Management (International) Limited and Parametric Portfolio Associates® LLC holds an exemption under Paragraph 9, 3rd Schedule to the SFA in Singapore to conduct fund management activities under an arrangement with EVMIA and subject to certain conditions. None of the other Eaton Vance group entities or affiliates holds any licences, approvals or authorisations in Singapore to conduct any regulated or licensable activities and nothing in this material shall constitute or be construed as these entities or affiliates holding themselves out to be licensed, approved, authorised or regulated in Singapore, or offering or marketing their services or products. Australia: This publication is disseminated in Australia by Morgan Stanley Investment Management (Australia) Pty Limited ACN: 122040037, AFSL No. 314182, which accept responsibility for its contents. This publication, and any access to it, is intended only for “wholesale clients” within the meaning of the Australian Corporations Act. EVMI is exempt from the requirement to hold an Australian financial services license under the Corporations Act in respect of the provision of financial services to wholesale clients as defined in the Corporations Act 2001 (Cth) and as per the ASIC Corporations (Repeal and Transitional) Instrument 2016/396. Calvert Research and Management, ARBN 635 157 434 is regulated by the U.S. Securities and Exchange Commission under U.S. laws which differ from Australian laws. Calvert Research and Management is exempt from the requirement to hold an Australian financial services licence in accordance with class order 03/1100 in respect of the provision of financial services to wholesale clients in Australia.

Japan:

For professional investors, this material is circulated or distributed for informational purposes only. For those who are not professional investors, this material is provided in relation to Morgan Stanley Investment Management (Japan) Co., Ltd. (“MSIMJ”)’s business with respect to discretionary investment management agreements (“IMA”) and investment advisory agreements (“IAA”). This is not for the purpose of a recommendation or solicitation of transactions or offers any particular financial instruments. Under an IMA, with respect to management of assets of a client, the client prescribes basic management policies in advance and commissions MSIMJ to make all investment decisions based on an analysis of the value, etc. of the securities, and MSIMJ accepts such commission. The client shall delegate to MSIMJ the authorities necessary for making investment. MSIMJ exercises the delegated authorities based on investment decisions of MSIMJ, and the client shall not make individual instructions. All investment profits and losses belong to the clients; principal is not guaranteed. Please consider the investment objectives and nature of risks before investing. As an investment advisory fee for an IAA or an IMA, the amount of assets subject to the contract multiplied by a certain rate (the upper limit is 2.20% per annum (including tax)) shall be incurred in proportion to the contract period. For some strategies, a contingency fee may be incurred in addition to the fee mentioned above. Indirect charges also may be incurred, such as brokerage commissions for incorporated securities. Since these charges and expenses are different depending on a contract and other factors, MSIMJ cannot present the rates, upper limits, etc. in advance. All clients should read the Documents Provided Prior to the Conclusion of a Contract carefully before executing an agreement. This material is disseminated in Japan by MSIMJ, Registered No. 410 (Director of Kanto Local Finance Bureau (Financial Instruments Firms)), Membership: the Japan Securities Dealers Association, The Investment Trusts Association, Japan, the Japan Investment Advisers Association and the Type II Financial Instruments Firms Association.

 

Esta es una comunicación con fines comerciales.

Es importante que los usuarios lean las Condiciones de uso antes de proceder, ya que explican ciertas restricciones legales y reglamentarias aplicables a la difusión de la información relativa a los productos de inversión de Morgan Stanley Investment Management.

Los servicios descritos en este sitio web pueden no estar disponibles en todas las jurisdicciones o para todas las personas. Para obtener más información, consulte nuestras Condiciones de uso.


Privacidad    •    Condiciones de uso

©  Morgan Stanley. Reservados todos los derechos.