How Investor Preferences for Hedge Fund Strategies Have Evolved During the Pandemic

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Pershing’s Prime Services regularly collects hedge fund capital introductions insights from private wealth and institutional investors. The data we’ve gathered in 2020 and 2021 highlights the changing preferences of investors as it relates to hedge fund strategies, asset classes and return expectations.

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Event-driven credit and structured credit, which were the most popular credit and fixed income strategies of 2020, were replaced in 2021 by multi-strategy and long/short (L/S) credit. While L/S equity remained the most popular equities strategy overall, generalist L/S strategies were overtaken by sector-focused healthcare and technology, media and telecommunications (TMT) strategies in 2021. Additional shifts in strategy preferences this year show increased investor interest in municipal bonds and infrastructure equity. In terms of return expectations, responses collected during Q3 2020 indicated that investors were expecting their hedge fund allocations to provide an 8-10% return, while current expectations in 2021 have risen to 10-16%.

Investors Are Shifting From Passive To Active Strategies

The increase in return expectations is a result of the more favorable market conditions for hedge funds in 2021. Investors’ concerns about market volatility, dislocations, and equity market drawdowns have led to outflows in low return passive strategies and inflows into actively managed fixed income or hedge funds. For those invested in passive fixed income (e.g., IG corporates and munis), interest rate risk is a key concern. As a result, investors are turning to hedge funds with a view to generating positive risk-adjusted returns regardless of the market environment.

Why The Change In Preference For Equity Strategies?

A reason for the shift that we’ve seen over the last 12 months from generalist to sector focused strategies is the surge in popularity of both the healthcare and TMT sectors. These sectors have experienced increased investor interest for several years now; however, the pandemic acted as a catalyst for investor interest and allocations. Additionally, with a proposed $1 trillion infrastructure spending plan in the works, investors have turned their attention to infrastructure equity strategies in order to take advantage of this.

Investors are seeking to avoid overlapping exposures and generate better performance by allocating to those sectors they believe to be benefitting from thematic tailwinds. There is also a requirement for investors to manage for strategy cyclicality, and we are seeing this play out with investors wanting specific sector exposure at different points in time.

Why The Change In Preference For Credit Strategies?

Until 2020, investors were shrinking their credit footprint on the trepidation that another unforeseen event, such as the global financial crisis, would come and create an outsized distressed cycle. This meant that relative value strategies and corporate credit were favored by some, but not the majority. Instead, many believed investment in credit should be limited to distressed. However, despite the pandemic, the distressed cycle was not as extensive as predicted, which left a lot of investors looking elsewhere.

Now, instead of distressed, investors are focusing their attention on L/S credit. There are many L/S credit managers performing well, especially those with expertise in picking high-yield sectors with attractive spreads. The popularity of multi-strategy credit is also rising, driven by institutional investors that lack the internal expertise and infrastructure needed to manage strategy cyclicality themselves. Investors don’t want the hassle of shifting their portfolio allocations themselves. They appreciate the skill of multi-strategy credit managers able to actively reallocate to credit strategies most favorable during a given time period. This desire for “autopilot” strategy management is perfect for investors with limited resources and who are happy with returns that are roughly expected of credit markets as a whole.

Lastly, despite significant losses being experienced as different parts of the market bottomed out during the pandemic, we have witnessed a notable level of demand for structured credit. From our conversations with investors, we attribute this for the most part to buying activity during 2020’s large correction in order to ride the rebound back up.