All hedge strategy sentiment took a hit in Q3 as popularity for long/short bonds and multi-strategy slipped to holding territory from a buying sentiment since Q2 2017, according to Last Word Research.
The quarterly asset class survey found that hedge long/short bonds had one of the largest negative quarterly shifts in sentiment with a 15.5 percentage point drop. Hedge multi-strategy followed with a 13.6 percentage point drop, and hedge long/short dropped by eight percentage points.
These shifts have dropped hedge long/short bonds from third most popular asset class (out of 26) in Q2 down to 20th in Q3. For hedge multi-strategy, this shift dropped the asset class to 11th in Q3 from 4th in Q2.
While sentiment for hedge long/short equity negatively shifted, it actually gained popularity and sat in the top spot for Q3 from 2nd in Q2.
Source: Last Word Research
Of the pan-European selectors surveyed, only 10% were looking to increase their hedge long/short bond allocation over the 12 months to September 2019, 26% to hold, 11% to decrease, and 53% did not use the asset class.
According to BarclayHedge’s latest fund flow indicator, despite global hedge assets reaching a high of $3.07trn (€2.7trn), continental Europe funds had the biggest August outflows of $3.2bn (-0.4% of assets).
Source: Last Word Research
Only 15% of the selectors wanted to increase their hedge multi-strategy allocation over the same time period, 31% to hold, 9% to decrease, and 44% did not use the asset class.
Source: Last Word Research
For the most liked hedge strategy, 28% wanted to increase their long/short equity over the same period, 33% to hold, 4% to decrease, and 35% did not use the asset class.
Alternatives scepticism
GAM head of multi-asset solutions, Julian Howard, said he was quite sceptical on alternatives as he believed the market to be quite constrained.
While Howard said he held some alternatives he was very selective in his choices. He said the chief culprit for alternatives performing poorly was the weak yields found on developed market bonds over the last four to five years, adding that the recent rise in yields had been negligible.
“Around 20 years ago alternatives used to give you a 7% return regardless of asset allocation but now the universe is really constrained and it’s basically producing nothing. The alternative three-year compound annual growth rate has been falling almost in lock-step with 10-year government bond yields,” he said.
“The macro index year to date is down nearly 2% and global hedge funds are similarly down so it’s been a terrible period for alternative investments for the last four to five years.”
While bond yields have started to pick up again, Howard said he doubted they would reach 5% but if they did then alternatives would be a viable choice.
Opportunities in alternatives
Howard noted that he liked merger arbitrage as it could generate a 4% compound rate over the long term with little equity correlation.
“Some market long/short and market neutral long/short managers can add value but I think it’s a very rare skillset but there are some people who can do it,” he said.
“If a macro manager says to me ‘oh there’s a lot of volatility you just got to wait it’ out my feeling is ‘I don’t want to wait it out I’ll buy equities and I’ll get the 7% compound rate that equities give over the long term.
“I think there are some alternatives that do work and I think the theory is good – low correlation, steady returns, there for you when markets roll over – but most of them took a dive when equities did at the beginning of the year”
Howard said his team liked alternative bonds like capital appreciation bonds and mortgage backed securities as they gave returns of around 3%-4.5% and did not go down with the market.
“A lot of older investors with memories of 20 years ago kind of lament on the days of 7% and think ‘surely it’s just picking the right managers’ but actually there’s been a secular shift away from that and of course there’s going to be two or three managers that have done great but the chances is that you wouldn’t have picked them because it’s a needle in a haystack,” he said.
“This year there’s been a lot of hedge funds that have collapsed and returns have been really poor and a couple have been liquidated. We’re just looking for low correlation, steady returns, and low volatility which seems like a simple thing to ask for and it does exist but you have to search quite hard.”
Howard said selectors needed to look at the history of the fund’s drawdown, how it looked against the equity market, what kind of trading was happening in the fund, and if the fund had independent ideas rather than trend following when picking a hedge or alternative fund.
