Diversifying into hedge funds and private markets can help investors access less-correlated returns. (ddp)

In hedge funds, we like uncorrelated strategies such as macro. Meanwhile, private market secondaries and distressed strategies could be well positioned to buy assets at attractive valuations.

Uncertainty and macro risks are likely to stay elevated.

  • While central banks are seeking to quell market concerns over financial stability on both sides of the Atlantic, fears of persistent price pressures and monetary policy are likely to stay in focus.
  • Alternatives should continue to play an important role in diversifying portfolios as long as investors are aware of the risks, including reduced liquidity, higher costs, and complexities.

Hedge funds can provide uncorrelated returns.

  • Historically, macro hedge funds have shown an ability to take advantage of tighter monetary policy, higher volatility across asset classes, and identify opportunities in uncertain economic environments.
  • Low net equity long-short strategies have shown they can benefit from market dispersion, mitigate market directionality, and complement traditional equity positions.
  • Multi-strategy funds can provide investors with highly attractive risk-return characteristics and strong portfolio effects in periods of market turmoil.

Private market investments also look compelling.

  • We generally prefer accessing growth opportunities through buyout and growth equity strategies, which should be less affected by the recent banking stress.
  • We recommend seeking exposure to value-oriented buyout strategies and expect transaction activity on the secondary market to accelerate.
  • We think private debt, particularly direct lending strategies, should prove resilient in the current environment.

Did you know?

  • Both hedge funds and private markets come with certain drawbacks, including the risk of an illiquid market. Investors need to be willing and able to lock up capital for longer.
  • Historically, when implied volatility has been elevated, equities have generated an average loss of 11.3%, while macro strategies were able to capitalize on market stress to produce 6.1% annualized returns.
  • Private market investments can provide attractive absolute risk-adjusted returns over the long term. Between 2001 and 2021, global private equity returned 13.8%annually, versus 7.1% in publicly traded global equities.
  • Direct lending, which represents most private debt assets, is senior in the capital structure and is extended to private-equity-backed companies with recurrent cash flows and solid financials.

Investment view

With uncertainty and macro risks likely to stay elevated, we recommend investors diversify into less correlated strategies such as hedge funds and private markets.

Main contributors - Daisy Tseng, Karim Cherif

Content is a product of the Chief Investment Office (CIO).

Original report - Can alternatives help navigate correlated markets?, 24 March 2023.