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juillet 27, 2020
AIP Hedge Fund Solutions Team Review and Outlook
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AIP Hedge Fund Solutions Team Review and Outlook

AIP Hedge Fund Solutions Team Review and Outlook

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juillet 27, 2020

 
 

Please see important disclosures at the end of this article.

In the second quarter, the hedge fund industry, as measured by the HFRI Fund Weighted Composite Index, posted its best results in over a decade, returning 9.0%. (Display 1) Most strategies benefited from aggressive central bank interventions and significant fiscal stimuli, and many were further buoyed by a succession of positive economic news that lifted credit markets and helped the S&P 500 Index record its highest quarterly return since 1998. While there were gains across all major strategies, Equity Hedge and Event Driven strategies stood out thanks to their higher equity and credit beta.

 
 
 
Display 1—Hedge Fund Industry Returns for the Quarter and YTD
 

Source: Hedge Fund Research, Inc., as of July 15, 2020. Past performance is not a guarantee of future results.

 
 

Within Equity Hedge, many long/short managers benefitted from beta exposure and capitalized on stock selection, sector focus and factor rotation. While many managers missed the April rally, having significantly reduced gross exposure in Q1, they rebuilt exposures during Q2.1  A common trend among managers included adding to pandemic-resilient longs in the technology and healthcare sectors while aggressively adjusting crowded short positions. Indeed, much of the quarter centered on adjusting risks according to economic and COVID-19 updates in addition to trading around extreme factor reversals in value, growth and momentum.

Long-side alpha generation was strong during the quarter, with the monthly average well above what we’ve seen since 2009. However, rapidly changing factor dynamics impaired short-side alpha as the tug-of-war between stay-at-home and work-from home themes affected typical growth/value and cyclical/defensive relationships. Further exacerbating short alpha results was extraordinary performance from deeply out of favor companies, such as Hertz, and high momentum stocks like Tesla and Twitter.  Overall, YTD alpha production was 4.3%, on par with some of the stronger recent years (Display 2).

 
 
 
Display 2: Global Alpha (Long – Short) as of June 2020
 

Source: Morgan Stanley Prime Brokerage – Strategic Content Group: June 2020 Hedge Fund Recap

 
 

Several of the larger multi-manager platforms delivered strong alpha in Q2, building on impressive Q1 performance. Platforms that can trade across equity, fixed income, currencies and commodity markets use highly specialized trading teams that collectively contribute to a single portfolio. Most of these platforms shifted exposure away from quantitative strategies and trimmed allocations to industrials, utilities and TMT market neutral sector specialists, instead favoring fixed income relative value and energy/commodities strategies. Rather than reflecting an explicit market view, platforms generally reallocated capital throughout the first half of the year to control target volatilities amid the unprecedented volatility expansion across risk factors. Their results reflected a high level of consistency throughout the market crisis and Q2.   

Event Driven strategies rose with the equity rebound, thanks to their inherent high beta exposure. Activist strategies were particularly notable, up 19.5% for the quarter. Multi-Strategy, Special Situations and Distressed/Restructuring substrategies2 benefitted from government bailouts and liquidity restoration brought about by the Federal Reserve’s March 23 bid for credit assets. After the announcement, high-yield spreads compressed from roughly 1,100 basis points to well below 700 basis points by quarter-end. The window to take advantage of the extreme dislocation was very narrow and very brief, with the first phase of recovery taking place in weeks. Performance across managers depended on their sector diversification and concentration of legacy pre-COVID-19 distressed holdings.  Managers with too much exposure to the top pre-COVID distressed sectors, such as transportation, energy, leisure and services, lagged, while those building positions led.

After providing strong downside risk mitigation during the acute phase of the pandemic, U.S. Macro strategies delivered positive albeit muted performance in Q2. Discretionary thematic strategies, with their active trading styles, fared better than systematic strategies. For instance, Discretionary Thematic managers were up 5.8% in Q2, focused on curve steepeners, a weaker U.S. dollar and higher yielding FX, a long bias toward emerging markets sovereign credit and gold. Commodity strategies benefited from exposure to industrial metals and rising gold and silver prices as well as nimble management of curve exposures across the energy complex. On the negative side, Systematic Diversified CTA managers struggled, down 2.5%. Losses were concentrated in major-market futures trend-following strategies, which were generally short developed market equity, metals and energy.  

OUTLOOK

As global interest rates are likely to remain near zero for the foreseeable future, we believe investors could add resilience to their portfolios by shifting some of their fixed income allocations into risk mitigating hedge fund strategies.

For instance, we believe macro strategies are poised to deliver upside and asymmetric payoffs. The combination of suppressed volatility, risk premia and spreads relative to high levels of uncertainty favors liquid discretionary macro funds. These strategies tend to have the flexibility to adjust portfolio composition and risk exposures, adapting to path-dependent updates to public health, geopolitical and policy issues; short-term systematic strategies can reorient risk quickly.

On the equity front, we see fertile alpha opportunity for strategies that limit market and factor exposures, with rewards for robust stock selection skill and specialized sector knowledge. With rapid shifts in today’s damaged business landscape and the government's intervention influencing winners and losers we are seeing a significant rise in disparities. Those with the fundamental knowledge and quantitative tools to identify leaders and laggards may have a competitive edge.

We believe we have entered the repair phase in the credit cycle, and this tends to be an attractive time for investors; however, selectivity and managing risks around legacy holdings and asset/ liability mismatches in a leveraged format requires a higher level of confidence and clarity than we have now. The speed at which structured credit markets seized and the underwriting assumptions used—both before and after COVID-19—suggest relatively high rewards for investors who can tolerate the commensurate higher risks.

The immediate investment landscape offers extremely compelling opportunities for hedge funds across a diverse array of macro, equity and fixed income strategies.  In our view, current conditions are creating a number of micro-climates in which certain hedge fund strategies are designed to thrive. Given the level of uncertainty around the globe stemming from the COVID pandemic and the potential volatility associated with upcoming U.S. elections, we believe portfolios can benefit from a thoughtful mix of high-quality hedge funds.

 
 

1 Morgan Stanley Prime Brokerage – Strategic Content Group: June 2020 Hedge Fund Recap

2 eSource: Hedge Fund Research Inc. as of July 20, 2020.

 
 

Index Descriptions

While the HFRI Indexes are frequently used, they have limitations (some of which are typical of other widely used indexes). These limitations include survivorship bias (the returns of the indexes may not be representative of all the hedge funds in the universe because of the tendency of lower-performing funds to leave the index); heterogeneity (not all hedge funds are alike or comparable to one another, and the index may not accurately reflect the performance of a described style); and limited data (many hedge funds do not report to indexes, and the index may omit funds, the inclusion of which might significantly affect the performance shown). The HFRI Indexes are based on information self-reported by hedge fund managers who decide on their own, at any time, whether or not they want to provide, or continue to provide, information to HFR Asset Management, LLC. Results for funds that go out of business are included in the index until the date that they cease operations. Therefore, these indexes may not be complete or accurate representations of the hedge fund universe, and may be biased in several ways.

Hedge Fund Research, Inc. (HFRI) Fund Weighted Composite Index: The HFRI Fund Weighted Composite Index is a global, equal-weighted index of over 2,000 single-manager funds that report to the HFR Database. Constituent funds report monthly net-of-all-fees performance in U.S. dollars, and have a minimum of $50 million assets under management or a 12-month track record.

Hedge Fund Research, Inc. (HFRI) Macro Index: The HFRI Macro Index consists of investment managers who 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. Managers employ a variety of techniques, including both discretionary and systematic analysis, combinations of top-down and bottom-up theses, quantitative and fundamental approaches, and long- and short-term holding periods. Although some strategies employ RV techniques, macro strategies are distinct from RV strategies in that the primary investment thesis is predicated on predicted or future movements in the underlying instruments, rather than realization of a valuation discrepancy between securities. In a similar way, while both macro and equity hedge managers may hold equity securities, the overriding investment thesis is predicated on the impact that movements in underlying macroeconomic variables may have on security prices, as opposed to equity hedge (EH), in which the fundamental characteristics of the company are integral to investment thesis, holding period, concentrations of market capitalizations and valuation ranges of typical portfolios.

Hedge Fund Research, Inc. (HFRI) Equity Hedge Index (long/short equity): The HFRI Equity Hedge Index consists of 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 and leverage employed.

Hedge Fund Research, Inc. (HFRI) Event Driven Index: The HFRI Event Driven Index consists of 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.

Hedge Fund Research, Inc. (HFRI) Relative Value Index: The HFRI Relative Value Index consists of investment managers who maintain positions where the investment thesis is predicated on the 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.

NYMEX (New York Mercantile Exchange) Heating Oil Futures Index:

West Texas Intermediate (WTI), also known as Texas light sweet, is a grade of crude oil used as a benchmark in oil pricing.

 
christopher.morser
Managing Director
AIP Hedge Fund Team
 
 
 
 

IMPORTANT INFORMATION

The views expressed herein are solely those of the AIP Hedge Fund Team (the “Investment Team”) and are subject to change at any time due to changes in market and economic conditions. The views and opinions expressed herein are based on matters as they exist as of the date of preparation of this piece and not as of any future date, and will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date hereof. The data used has been obtained from sources generally believed to be reliable. No representation or warranty is made as to its accuracy, completeness, fairness or suitability.

Information regarding expected market returns and market outlooks is based on the research, analysis, and opinions of solely the Investment Team. These views do not represent views of other investment teams at Morgan Stanley Investment Management or those of Morgan Stanley as a whole. These conclusions are speculative in nature, may not come to pass, and are not intended to predict the future of any specific investment.

Certain information contained herein constitutes forward-looking statements, which can be identified by the use of forward-looking terminology such as “may,” “will,” “should,” “expect,” “anticipate,” “project,” “estimate,” “intend,” “continue” or “believe” or the negatives thereof or other variations thereon or other comparable terminology. Due to various risks and uncertainties, actual events or results may differ materially from those reflected or contemplated in such forward-looking statements. No representation or warranty is made as to future performance or such forward-looking statements.

 

Past performance is not indicative of nor does it guarantee comparable future results.

This piece is a general communication, which is not impartial, and has been prepared solely for informational purposes and is not a recommendation, offer, or a solicitation of an offer, to buy or sell any security or instrument or to participate in or adopt any trading or other investment strategy. This communication is not a product of Morgan Stanley’s Research Department and should not be regarded as a research recommendation. The information contained herein has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

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 its and their respective directors, officers, employees, members, general and limited partners, sponsors, trustees, managers, agents, advisors, representatives, heirs, successors and assigns 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 accuracy, completeness, fairness 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.

 

Funds of funds often have a higher fee structure than single manager funds as a result of the additional layer of fees. Alternative investment funds are often unregulated and are not subject to the same regulatory requirements as mutual funds, and are not required to provide periodic pricing or valuation information to investors. The investment strategies described in the preceding pages may not be suitable for your specific circumstances; accordingly, you should consult your own tax, legal or other advisors, at both the outset of any transaction and on an ongoing basis, to determine such suitability.

Global Pandemics. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them. Market values can change daily due to economic and other events (such as natural disasters, epidemics and pandemics, terrorism, conflicts and social unrest) that affect markets generally, as well as those that affect particular regions, countries, industries, companies or governments. It is difficult to predict when events may occur, the effects they may have (e.g. adversely affect the liquidity of the portfolio), and the duration of those effects.

Morgan Stanley does not render tax advice on tax accounting matters to clients. This material was not intended or written to be used, and it cannot be used with any taxpayer, for the purpose of avoiding penalties which may be imposed on the taxpayer under U.S. federal tax laws. Federal and state tax laws are complex and constantly changing. Clients should always consult with a legal or tax advisor for information concerning their individual situation.

The information contained herein is proprietary and protected under copyright and other applicable laws, and may not be reproduced or distributed. This communication 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.

 

Index data is provided for illustrative purposes only. Indexes do not include any expenses, fees or sales charges, which would lower performance. Indexes are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.

NOT FDIC INSURED | OFFER NOT BANK GUARANTEED | MAY LOSE VALUE | NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY | NOT A BANK DEPOSIT

 

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