Second Quarter 2021 – UBS Hedge Fund Solutions Strategy Outlook

The US shows strong results coming out of Q1 2021 as vaccine progress and reopenings accelerate, largely outpacing expectations.

28 Apr 2021 14 min read

Macro thoughts and portfolio themes

The US shows strong results coming out of Q1 2021 as vaccine progress and reopenings accelerate, largely outpacing expectations. Outside of the US, many geographies are still early cycle with recoveries moving at different speeds. Notably, Europe and emerging markets may outperform if they catch-up with the US and east Asia. Unfortunately, COVID cases continue to rise on a global basis, driven by emerging markets. The longer the pandemic lasts in any region subjects the global population to the risk of future variants that can evade vaccines.

The message from global central banks is clear, consistent and supportive. US fiscal stimulus in Q1 was robust and at the higher range of what investors anticipated. However, future support and spending, including for infrastructure, will likely be tied to measures offsetting some of the deficit impact, such as increased taxes. While it’s clear higher inflation will be tolerated in the US, market participants will closely watch all official and ad hoc statements from the Fed to discern future policy direction for the timing and pace of rate hikes. The Fed and ECB have meetings in June that could offer guidance. In addition to an overall bullish commodity cycle, rising input costs due to strained supply chains and tariffs, and pressure on labor costs due to pandemic-related shortages / relocations could accelerate the timelines. Following successes around COVID containment, and strongly rebounding growth, China began removing stimulus and rolling back credit availability. Downstream effects on emerging economies and commodity producers will be in focus. Some EM central banks may also hike to keep pace with the rise in Treasuries.

The market appears to be in a period of consolidation after Q1 2021’s swift but volatile moves in rates, US dollar and cyclical / value equities. Longer-term, we believe this is a positive development for fundamental strategies and may allow for a two-sided opportunity set to emerge. Some of the excesses in the marketplace, including those driven by retail activity, seem to be settling down. The rate of money supply expansion should also slow. Overall, we are cautious on equity beta and have some downside concerns if hiccups were to occur. The positive news in the US has largely been pulled forward with the stimulus and priced into lofty valuations. The Biden administration has shown highly assertive stances on foreign policy, which could introduce some geopolitical surprises. Cyber security continues to be an ever-present tail risk. Additionally, the new administration still has some final regulatory appointments / confirmations for positions such as the FTC and DOJ Antitrust Division heads, which can potentially impact the technology sector.

The market appears to be in a period of consolidation after Q1 2021’s swift but volatile moves in rates, US dollar and cyclical / value equities.

Portfolio positioning

We continue to expect market volatility to subside as economies normalize and reopen, allowing a return to fundamentals that can drive long and short alpha.

  • Our strategy allocations remain largely unchanged. We favor Equity Hedged to take advantage of a return to fundamentals and Trading to capitalize on broad moves related to the uneven pace of re-opening.
  • Additionally, we continue to look for pockets of mispriced opportunities in Credit and sub-strategies with persistent volatility in Relative Value.
  • At the beginning of Q2 2021, we increased our platform allocation to the SPAC (special purpose acquisition companies) strategy. We are researching how to best access the robust corporate events opportunity set.

CIO model portfolio and sub-strategy outlook

Strategy - Equity Hedged

Sub-strategy

Sub-strategy

Target weight %

Target weight %

Outlook

Outlook

Sub-strategy

Fundamental

Target weight %

20

Outlook

-

Sub-strategy

Equity Event

Target weight %

6

Outlook

Positive

Sub-strategy

Opportunistic Trading

Target weight %

9

Outlook

-

Sub-strategy

Equity Hedged total

Target weight %

35

Outlook

-

Strategy - Credit / Income

Sub-strategy

Sub-strategy

Target weight %

Target weight %

Outlook

Outlook

Sub-strategy

Distressed

Target weight %

2

Outlook

-

Sub-strategy

Corporate Long / Short

Target weight %

6

Outlook

Negative

Sub-strategy

Asset Backed Securities

Target weight %

6

Outlook

-

Sub-strategy

Reinsurance / ILS

Target weight %

1

Outlook

-

Sub-strategy

CLO / Corporate Lending

Target weight %

-

Outlook

-

Sub-strategy

Other Income

Target weight %

1

Outlook

-

Sub-strategy

Credit / Income total

Target weight %

16

Outlook

-

Strategy - Relative Value

Sub-strategy

Sub-strategy

Target weight %

Target weight %

Outlook

Outlook

Sub-strategy

Merger Arbitrage

Target weight %

2

Outlook

-

Sub-strategy

Capital Structure / Volatility Arb

Target weight %

8.5

Outlook

Positive

Sub-strategy

Quantitative Equity

Target weight %

6

Outlook

-

Sub-strategy

Fixed Income Relative Value

Target weight %

6

Outlook

Negative

Sub-strategy

Agency MBS

Target weight %

2.5

Outlook

Negative

Sub-strategy

Relative Value total

Target weight %

25

Outlook

-

Strategy - Trading

Sub-strategy

Sub-strategy

Target weight %

Target weight %

Outlook

Outlook

Sub-strategy

Systematic

Target weight %

1

Outlook

-

Sub-strategy

Discretionary

Target weight %

19

Outlook

-

Sub-strategy

Commodities

Target weight %

4

Outlook

-

Sub-strategy

Trading total

Target weight %

24

Outlook

-

Equity Event - Positive

  • With fiscal stimulus and re-opening trades now largely priced in, we expect beta tailwinds and rotational pressures to ease presenting the opportunity to reclaim alpha through shorts and increased dispersion
  • Increased M&A activity and the emergence of SPAC acquisitions leads to opportunities in other non-merger transactions: special situations, including pre-and post-event equity, spin-offs and stub trades

Corporate Long / Short - Negative

  • Corporate credit markets have largely recovered, however, managers are now focused on shorting duration-sensitive issuers as rate risk—rather than credit risk—is now of greater concern

Capital Structure / Volatility Arb - Positive

  • Within SPACs, we believe meaningful pockets of value and mispriced optionality with exceptional convexity are being overlooked as market indicators begin to normalize over time

Fixed Income Relative Value  - Negative

  • We continue to maintain a meaningful allocation within FIRV strategies. We believe that managers with a diversified approach by region and sub-strategy (bond / swap RV, inflation, mortgages, cross-market and macro) are best positioned, and that Macro RV will likely outperform Micro RV approaches, such as cash / futures basis

Strategies