Volatile markets offer great opportunities to those who know how to take advantage of them. “The volatility we have witnessed across most asset classes really plays into the hands of managers who are able to be flexible,” says Tim Gascoigne, global head of portfolio management at HSBC Alternative Investments, which manages $38bn (€27.8bn) in total assets.
Hedge fund managers have a flexible way of entering markets and generating alpha. They have more tools at their disposal and more freedom than the typical long only manager. They are able to be long and short and are allowed to use a wide range of derivative instruments. They have the ability to gross up or down leverage and they don’t have a mandate to be fully invested. This allows them to reduce risk when they foresee volatile times across markets, which is an advantage over long only managers, who have to be fully invested at all times.
“Given the uncertain outlook for equity markets, because of the uncertain macro economic backdrop, having an allocation to hedge funds does make sense,” maintains Mr Gascoigne.
But not all strategies work well today. When the outlook for equity markets is mixed and equity markets are trading on macro concerns rather than on the individual companies’ profitability, it is better to have more risk in macro and trend followers vis-a- vis equity long short. “In our portfolio we have higher than average allocation to trend followers and higher than average allocation to discretionary macro,” he says.
“Equity long short is a great strategy for our funds, but if the underlying company share prices aren’t moving in line with what these companies are doing and the outlook for those companies’ earnings, then it is more difficult for stockpickers to make money and so we tend to reduce allocation in those environments.”
Discretionary macro strategies are particularly suited to the current environment. The best macro managers have been positioned to profit from the rise in volatility at the end of July through August, after the downgrade of the US by Standard & Poor’s. They have been generating strong returns by tactically trading US Treasuries and a variety of other positions, for example widening swap spreads over treasuries, as markets really appraise the risk in itself of the banking sector, particularly in Europe.
These strategies also made money from currency positioning, and the overvaluation of the Swiss franc has created opportunities for those managers positioned in the right way, as they took profit from the Swiss National Bank’s decision to weaken the currency.
The trend-following strategies have also been positive. The short-trend following systems have benefited from the high volatility in equity markets and have generated good returns in August, says Mr Gascoigne.
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“It is very difficult to be right predicting when trends will emerge and will stop, but at the moment, in this risk off trading environment, a decent trend is that bond yields are falling because US Treasuries have been used as a risk off investment, even though that’s the asset which many people are worried about.” Another positive trend is the long positioning in precious metals.
While the hedge fund industry is dominated by the US, Asia is the most appealing region for investments. “We like Asia, as it is a less crowded market for hedge fund investors,” says Mr Gascoigne. “We have increased allocation to Asian dedicated partners within our portfolios over the last 12 months and we will continue to do that going forward.”
Asset allocation, which reflects long-term appraisal of opportunities, is important but selecting the right managers is absolutely key. “There are decent changes to asset allocation within our funds, but what drives performance is manager selection from the underlying managers,” he says, explaining that many of the managers they employ are multi-strategies.
“When you are managing a portfolio of hedge funds, you can’t tactically move allocations around that easily because of the redemption terms of the funds. You just have to have a long-term view and find the right managers for that.”
On HSBC’s platform, 80 per cent of the returns are generated by manager selection and 20 per cent from asset allocation calls, he says. Over the next six months, Mr Gascoigne expects his balanced portfolio of hedge funds will deliver from 6 to 8 per cent returns.
“Markets have been very difficult over the last couple of months, but that will wind itself out over the last quarter of the year, and there will be a tail wind for certain strategies over the next three to six months.”
