By Donald A. Steinbrugge, CFA
As you may know, the GAIM hedge fund conference is one of the largest and oldest hedge fund conferences in the industry and took place in Monte Carlo. The biggest take a ways from the conference include:
Most investors are concerned with high valuations within the fixed income capital markets and believe the US Fed will begin to increase rates later this year. As a result they are reducing the risk in their fixed income portfolios.
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GAIM Hedge Fund Conference: Fixed income portfolio risk reduction
They expect the treasury yield curve to continue to rise (10 year US Treasuries QE 1.92% vs 2.26% as of 6/19). Market anticipating September or December Fed rate hike. They also expect credit spreads to widen which have continued to tighten YTD. As a result hedge fund investors are reducing risk in their fixed income portfolio by:
- Reducing allocation to high yield credit (concerned about large amount in ETFs and mutual funds with daily liquidity. Large withdrawals could cause significant widening of credit spreads)
- Reducing allocation to US focused structured credit and distressed debt, although still like these strategies focused on Europe.
- Reducing the duration/hedging their fixed income portfolios
- Increasing allocation to relative value fixed income. This is a broad category that covers managers that hedge a large percent of their duration and credit exposure and generate returns through security selection and potentially active trading in less liquid markets. The key here is fully understanding their risk controls and the securities in which they invest. For example, a manager may only invest in long maturity floating rate securities that have very little duration risk, but significant spread risk.
- Increasing allocation to private lending. These are direct loans to small and mid-sized companies filling a void created by banks reluctance to lend to the companies. Credit spreads on private lending over in Europe have not tightened similarly to other credit securities due to the difficulty in mid-sized companies getting financing. It is very important that these funds are structured like private equity funds due to the illiquidity of the underlying investments.
The GAIM participants were also concerned about a rise in interest rates that will also cause increase in the volatility of financial markets as well as an increase in correlations among fundamentally oriented strategies (people are not as diversified as they think if we experience a market sell off as correlations increase).
GAIM Hedge Fund Conference: Strategies with low correlation to the capital markets
In addition to direct lending and relative value fixed income, other strategies with low correlation to the capital markets and potential to reduce downside volatility include:
- Commodity Trading Advisors (CTAs) This includes a lot of different strategies, but are dominated by systematic trend following managers that identify price trends across multiple asset classes, including: currencies, commodities, equities and fixed income. Trend following was the top performing hedge fund strategy in 2014 and has worked well over long periods of time including up double digits in 2008.
- Market Neutral Equity – Net exposure is typically between plus or minus 10%.
- Global Marco – Similar to CTAs, however they use fundamental analysis to determine where to invest along with a discretionary decision making process
- Reinsurance funds – Obviously very low correlation between hurricane and earthquakes with the capital markets.
Greece was viewed as a problem that is not going away regardless of the outcome of current debt negotiations. Greece on its own is not important to Europe’s over all GDP, however it creates uncertainty relative to the EU and Euro which will increase volatility in the capital markets.
Global equity valuations are well above historical averages. Europe is trading at a discount to US and expected to benefit from weak Euro with strong earnings growth.
Finally there was some discussion relative to Hillary Clinton’s comments on how much hedge fund managers make. Views were given that it was unfair to focus on one industry, especially when most of the hedge fund managers are struggling to raise assets.