November was a strong month for hedge funds, as it was the best since January. The HFRI Fund Weighted Composite Index was up 2.2% in the month, while the HFRI 500 Equity Hedge Index climbed 4.3% in November. The latter was the biggest gain since February 2021, according to Hedge Fund Research.
However, there was quite a dispersion in returns, as the top decile of the composite index gained 12.9%, while the bottom decile averaged a -6.5% return. The dispersion is even more stark through the first 11 months, as the top decile gained 30.9% while the bottom decile fell 16.5%, according to HFR data.
Thus, while November was a good month, there has obviously been a significant bifurcation of returns, which has been exacerbated by persistent macroeconomic challenges. Year to date, the HFRI 500 Equity Hedge Index is up 3.8%; meanwhile, the index is up 2.6% over the past year through November.
As 2024 approaches, investors may be wondering if the positive momentum from November will continue into the new year. The long and short of it is that it all depends on where you look.
The long and the short of it
Next year should be a positive one for equity long/ short (ELS) hedge funds, experts say. Long/ short funds are those that include long positions in investments the managers believe are good values and will outperform over the long term. These funds also include short positions, enabling the managers to bet against those they believe are overpriced and will underperform. In November, the HFRI EH Long/Short Index shot up 4.5%.
Joseph Marenda, head of Hedge Fund Research and Digital Assets Investing at Cambridge Associates, expects ELS funds to continue to outperform. He said in a recent 2024 hedge fund outlook that ELS funds will likely exceed their long-term averages next year. Among other factors, Marenda cited the rise in short rebates, which are the returns on the collateral the manager puts up to short the security.
“Higher short-term interest rates have increased the short rebate to levels unseen since the GFC (global financial crisis),” Marenda wrote in his outlook. “In fact, a fund’s short book now generates yields greater than benchmark equity dividend yields for the first time since 2008. A higher short rebate improves potential future performance, as it lowers the cost of carrying short positions and increases the opportunity set for single-name shorts.”
Further, Marenda said the expected sluggish economy should create good cheap buys and potentially more opportunities for shorts of overpriced assets in 2024, which would potentially benefit ELS managers.
Next year could also bring a favorable environment for market-neutral funds, which are ELS funds with low or no beta that are designed to minimize risk and perform well in down markets. A recent analysis by Morgan Stanley showed that market-neutral strategies have outperformed the broader markets in past downturns, including the 2000-to-2002 market decline, through the 2007-2008 GFC, and up through the COVID-19 and 2022 bear markets.
Outperformance in uncertain times
How the broader markets will actually perform in 2024 remains to be seen. There is a lot of uncertainty for next year, with some economists predicting an economic slowdown and most analysts calling for below-average returns on the stock markets. Additionally, about 50% of the world’s population will be electing leaders this year, and the outcomes could have significant impacts on world economies, depending on which way they go.
However, the overall trends indicate that ELS funds in general and lower-risk market-neutral portfolios may be worthwhile options to consider to beat the markets and provide downside protection in a potentially volatile environment.
