Hedge funds: The Red Thread – Alternatives

Echoes of growth amid whispering risks

4Q25 outlook

Despite recent data pointing to stagnating US labor demand and political impasses about elevated fiscal spending on both sides of the Atlantic, equity markets continue to march higher, while credit spreads remain firmly at historical lows. With most central banks appearing more dovish and with fiscal support well into 2026, recession odds seem muted. We believe the tariffs’ impact on imported goods has yet to peak; however, we observe offsetting price trends in housing and crude oil. Declining nominal wage growth may also act as a headwind for inflation. As US inflation remains under control at approximately 3%, pro-growth policies, especially in the US, should continue to support both the global economy and risk assets into next year.

Yet, there are a few reasons for concern as we move into 2026:

Real wage growth in the US is slowing, while the job market remains in near-perfect equilibrium (for now). With 50% of consumption driven by the top 10% of the income distribution, consumption and GDP are increasingly dependent on the wealth effect generated by rising asset prices.
Artificial intelligence (AI) capex is another major contributor to US growth. However, much of the spending so far is justified by expected returns that have yet to materialize. We have not seen meaningful enterprise adoption leading to measurable productivity gains.
Initial warning signs are emerging in US HY credit markets after three years of elevated interest rates and more recent impact of tariffs.
Valuations for risk assets and positioning, while not extreme, are certainly elevated, predominantly in the US.

As such, we are marginally shifting toward a more conservative positioning within our portfolios, reducing beta by exchanging some of our more directional equity hedged strategies and credit in favor of relative value strategies.

Strategy views

In equity hedged, we are taking some profits in more fundamental strategies, especially in technology, following two years of very strong performance. We remain bullish on long-term AI adoption but are cautious about a potential short-term recalibration of capacity expansion targets and equity valuations. We continue to diversify across regions and plan to increase allocations to Pan-Asia equity hedged strategies. Markets in Japan and South Korea are benefitting from shareholder-friendly corporate reforms and renewed interest from foreign investors.

In China’s equity markets, stock pickers’ focus remains skewed toward AI and technology; nevertheless, rising retail participation should support gradual expansion of alpha opportunities. We believe financials, biotechnology, and, to a lesser extent, technology will continue to represent the majority of sector specialists’ alpha.

We are further reducing credit/income allocations, acknowledging extremely narrow credit spreads and liquidity risk premia. Recent corporate credit events in the US appear to be isolated cases of balance sheet mismanagement rather than the start of a major distressed cycle. However, fatigued lower income consumers, elevated interest expenses (especially for loans), and tariffs could potentially lead to further corporate mishaps and overall credit spread volatility. As such, we remain constructive on credit long/short, as opportunities could emerge on both sides of the portfolio. We are carefully reassessing risk-reward for our reinsurance exposure as we approach contract renewals for next season. Despite wildfires impacts early in the year, pricing appears to have peaked in many segments and is expected to soften in 2026.

In relative value, we continue to hold our exposure in fixed income relative value as we expect opportunities to broaden beyond traditional cash/futures basis trading, especially in Europe. We are reallocating some of the proceeds from credit/income into quantitative equity sub-strategies. The focus remains on short- to medium-term frequency statistical arbitrage with global breadth. We are turning more constructive on merger arbitrage as global M&A volumes pick up (albeit from a low level). Nevertheless, we remain cognizant of relatively tight spreads and potential crowding from any inflows from multi-strategy funds. Further increases in merger volumes and one or two merger break-ups could potentially create tactical entry points.

Hedge funds sector performance outlook¹

Country	Country	Negative	Negative			Neutral	Neutral			Positive	Positive
Country	All regions	Negative	EH-fundamental, Credit-asset-backed, Credit-other income		None	Neutral	None		None	Positive	EH-opportunistic trading, RV-quant equity, Trading-systematic