Strategy Outlook

At present, US unemployment remains high, and the resurgence of COVID-19 has hit consumers’ incomes in meaningful ways, stalling the recovery. We are in the midst of what will be a tough few months in terms of human impact and economic activity. However, many economists believe the risk of recession is negligible because of the impact of fiscal stimulus and evidence that, overall, households were able to increase savings. Unless derailed by virus mutations, re-opening bump to US GDP is widely expected in Q2 2021 from both pent-up consumer demand, forestalled corporate investment and stimulus.

The market is clearly comfortable that positive vaccine news and eventual wider deployment will bridge us toward some level of immunity by summertime. However, the question that remains is how much of this reflationary view is already priced into a market with high valuations and tight risk premia. The investment implications of an inflationary environment are significant, and signs of inflation will be closely monitored. Commodities and basic materials have started to reprice, and housing is also squeezed. The sum of tools in the hands of Congress, the Federal Reserve and US Treasury can be deployed in a way that encourages inflation, which the Fed signaled it will tolerate. Moreover, former Fed Chair Yellen’s confirmation atop the Treasury with bipartisan political support could signal a possibility for coordinated actions.

Equity Hedged

HFS plans to increase allocations to Equity Hedged (EH) and will seek to position portfolios in regions and sectors with persistent volatility and higher dispersion. In the US, we are looking to add US generalist managers and maintain our focus on biotech. However, we are mindful of elevated gross exposure levels, overall concentration to growth vs. cyclicals or value, and the presence of an emerging retail factor which disregards fundamentals and can challenge short side investing. We have high conviction in the EH opportunity set over the longer-term. Positive secular and market forces continue in APAC and Greater China, including consumption reshoring / quality upgrades and trends in sectors like healthcare. US / China tensions around Executive Orders and ADRs require monitoring, as does the potential for China to withdraw some fiscal policy stimulus. Japan corporate event activity is also an ongoing theme. We are researching European Equity Hedged managers, where performance has generally lagged other regions. Political risk is now lighter and thematic growth may be possible around recovery spending and green stimulus.

Source: Bloomberg, HFS; Daily data; Jan 1, 2020–Dec 31, 2020. Data illustrates the performance of 75th percentile stock in the respective industry group subtracted by the 25th percentile stock in that industry group. Size of circle indicates the number of observations within each sector. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.

Credit / Income

HFS allocated to Credit / Income in 2020 through tactical long / short managers and through other longer-biased approaches to take advantage of dislocations. Most sectors have now rebounded aside from notable exceptions, such as CMBS and lower quality CLOs. Our existing ABS, RMBS and Agency MBS allocations will likely be on hold, unless we uncover opportunities that offer yield with possibility for incremental capital appreciation. In corporate credit, while managers could also benefit from a return to fundamentals, we see this area as less attractive due to present tightness from policy support and ongoing yield chasing, as well as lack of defaults and downgrades. However, we believe this does set-up well for hedged credit managers adept at finding short opportunities.

Source: Bank of America Merrill Lynch; Daily data; Jan 3, 2006–Dec 31, 2020. Indices are for illustrative purposes only. Please see end notes for index descriptions.

Relative Value

HFS reduced Relative Value (RV) in 2020—starting with quant equity, then merger arb and then Fixed Income Relative Value (FIRV)—to fund other opportunities. Capital Structure / Volatility Arbitrage remains in focus as companies access financing via convertibles. Special purpose acquisition companies (SPACs) are also driving this strategy and attracting capital from Merger Arb and Multi-Strat managers. While we consider SPACs an interesting asymmetric trade on a leveraged basis, we remain attentive to how flows, liquidity and possible regulatory change could alter the dynamics. In Agency MBS, the Ginnie Mae project loan (GPL) sector is our highest conviction theme given the increase in prepayment speeds. FIRV still remains a meaningful allocation and could benefit somewhat from steeper yield curves. However, expectations of lower fixed income volatility and the wide availability of balance sheet financing can diminish opportunities and thus lower our return expectations.

Source: UBS, Bloomberg; Weekly data; Jan 2, 2015–Jan 8, 2021. Data includes definitive deals with median spreads ranging from 0% to 50% and have more than five days to closing. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.

Trading

Within Trading, HFS is likely to increase allocations to commodity-focused traders while maintaining our allocations to discretionary macro managers. Our view on developed markets (DM) Trading is still moderately positive despite expecting volatility to subside, as well as concerns on crowding and consensus positioning. With front-end rates anchored at zero, the debate around whether policy can create inflation can still manifest in vol further out along the yield curve, providing opportunities for macro RV approaches. We are comparatively more cautious on Emerging Markets (EM). Despite higher real yields and dispersion, EM risk premia has compressed. As managers seek to hedge out duration or inflation risk, these hedges could leave them somewhat exposed in a flight-to-quality scenario. HFS typically maintains low exposure to the Commodities strategy, but the blue wave signals change in energy policy and infrastructure spending, thus catalyzing two-way drivers in commodities that could play out over years. Furthermore, a demand pickup and potential supply response can quickly add to volatility in the near term.

Source: Bloomberg; Daily data; Jul 1, 2020–Dec 18, 2020. Indices are for illustrative purposes only. Please see endnotes for index descriptions. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.