First Quarter 2021 UBS Hedge Fund Solutions Strategy Outlook

With the blue wave culminating from the Georgia run-off, we expect a large fiscal stimulus in the near term.

26 feb 2021

Macro thoughts and portfolio themes

With the blue wave culminating from the Georgia run-off, we expect a large fiscal stimulus in the near term. The higher Treasury rates we observed after the run-off were well anticipated and a consensus position for many managers. Already, the policy backdrop continues to be supportive, with global Central Banks eager to stimulate signs of inflation. With Democrat control, investors need to weigh the positives of fiscal stimulus and also contemplate the potential impact of higher corporate and individual taxes, increased regulation and measures to combat inequality such as a higher minimum wage. That said, Democrats have only a thin majority, and this provides a check on the most far-reaching of their policy plans.

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.

A re-opening bump to US GDP is widely expected in Q2 2021 from pent-up consumer demand, forestalled corporate investment and the new COVID recovery stimulus.

Portfolio positioning

As we get past the transition period to the new administration, volatility levels could moderate further.

  • This should allow investors to focus on micro analysis and company fundamentals instead of the macro backdrop, which has consumed investors in 2020.
  • Our view is that a return to fundamentals, along with the normalization of economies and market behavior, are expected to be drivers of alpha on long / short trades. After periods of elevated correlation and volatility, which we experienced in 2020, we tend to see an attractive alpha environment.
  • Within portfolios, we seek to take advantage of dispersion and be positioned in places where volatility could persist. As such, we expect to increase allocations to Equity Hedged and commodity-focused Trading managers.

CIO model portfolio and sub-strategy outlook

Q1 2021 Forward looking

 Strategy & sub-strategies

 Strategy & sub-strategies

Target weight %

Target weight %

Outlook

Outlook

 Strategy & sub-strategies

Equity Hedged

Target weight %

-

Outlook

-

 Strategy & sub-strategies

Fundamental

Target weight %

20

Outlook

Positive

 Strategy & sub-strategies

Equity Event

Target weight %

5

Outlook

Positive

 Strategy & sub-strategies

Opportunistic Trading

Target weight %

9

Outlook

-

 Strategy & sub-strategies

Equity Hedged total

Target weight %

34

Outlook

-

 Strategy & sub-strategies

Credit / Income

Target weight %

-

Outlook

-

 Strategy & sub-strategies

Distressed

Target weight %

2

Outlook

-

 Strategy & sub-strategies

Corporate Long / Short

Target weight %

7

Outlook

-

 Strategy & sub-strategies

Asset Backed Securities

Target weight %

6

Outlook

-

 Strategy & sub-strategies

Reinsurance / ILS

Target weight %

1

Outlook

-

 Strategy & sub-strategies

CLO / Corporate Lending

Target weight %

-

Outlook

-

 Strategy & sub-strategies

Other Income

Target weight %

1

Outlook

Negative

 Strategy & sub-strategies

Credit / Income total

Target weight %

17

Outlook

-

 Strategy & sub-strategies

Relative Value

Target weight %

-

Outlook

-

 Strategy & sub-strategies

Merger Arbitrage

Target weight %

2

Outlook

-

 Strategy & sub-strategies

Capital Structure / Volatility Arb

Target weight %

7

Outlook

-

 Strategy & sub-strategies

Quantitative Equity

Target weight %

6

Outlook

-

 Strategy & sub-strategies

Fixed Income Relative Value

Target weight %

7

Outlook

Negative

 Strategy & sub-strategies

Agency MBS

Target weight %

3

Outlook

-

 Strategy & sub-strategies

Relative Value Total

Target weight %

25

Outlook

-

 Strategy & sub-strategies

Trading

Target weight %

-

Outlook

-

 Strategy & sub-strategies

Systematic

Target weight %

1

Outlook

-

 Strategy & sub-strategies

Discretionary

Target weight %

19

Outlook

-

 Strategy & sub-strategies

Commodities

Target weight %

4

Outlook

Positive

 Strategy & sub-strategies

Trading total

Target weight %

24

Outlook

-

Fundamental: Positive outlook

  • HFS expects fundamentally-driven stock dispersion to support two-way alpha generation on both the long and short sides of portfolios

Equity Event: Positive outlook

  • Recent elections increased the likelihood of greater US fiscal stimulus, while successful vaccine trials provide a rough timeline for the normalization of economy
  • A reopening / recovery could support possible sector rotation toward cyclicals and a rebound of event activity

Fixed Income Relative Value: Negative outlook

  • Modest expected returns due to lower volatility and fewer trades in themes such as US cash / futures basis, EU periphery spread trading and LIBOR transition

Commodities: Positive outlook

  • HFS has a positive outlook for discretionary commodities approaches given higher expected volatility and a possible reflationary environment under a Biden Presidency, which is likely to place greater attention on environmental issues and infrastructure spending

Strategies

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.

US dispersion by industry group

US dispersion by industry group, charts performance of 75th percentile stock in the respective industry group subtracted by the 25th percentile stock in that industry group from 1 January 2020 – 31 December 2020. Size of circle indicates the number of observations within each sector.

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.

High yield market spreads

High yield market spreads, charts option adjusted spreads (bps) of BofA High Yield Index, B spread, BB spread and CCC spread from 3 January 2006 – 31 December 2020.

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.

Median annualized merger arbitrage spreads

Median annualized merger arbitrage spreads, charts the median deal spreads (%) from 2 January 2015 to 8 January 2021.

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.

30 day rolling volatility of copper, WTI, soybeans, gold

30 day rolling volatility of copper, WTI, soybeans, gold, charts the volatility (%) of copper, WTI, soybeans and gold from 1 July 2020 to 18 December 2020.


Podcasts: What's trending in hedge funds?

Want to learn more about the outlook for hedge funds? Listen as Bruce Amlicke, CIO of UBS Multi-Manager Solutions answers questions being asked in the hedge fund space today.

Learn more about the macro backdrop for hedge funds including the main drivers of the reflationary environment, what it means for asset allocation and how trends like the rising retail investment community may be a positive for hedge funds.

Listen as Bruce discusses what transpired to cause the equity short squeeze which triggered hedge fund de-risking and repositioning, how hedge funds recovered and what this may mean for their approach to short portfolios going forward.

Although the reflationary landscape is the consensus view of hedge funds, there still lies potential risk that may require quick repositioning. Learn more about how hedge funds view today’s environment and what changes may affect future allocations.

Index descriptions

The use of indices is for illustrative purposes only.

BofA Merrill Lynch US High Yield Master II (H0A0) Index

The BofA Merrill Lynch US High Yield Master II (H0A0) Index tracks the performance of below investment grade US dollar-denominated corporate debt publicly issued in the US domestic market. Qualifying securities must have a below investment grade rating (based on a composite of Moodys, S&P and Fitch) and an investment grade rated country of risk. In addition, qualifying securities must have at least one year remaining term to maturity, a fixed coupon schedule and a minimum amount outstanding of USD 100 million. Original issue zero coupon bonds, ‘global’ securities (debt issued simultaneously in the Eurobond and U. S. domestic bond markets), 144a securities and pay-in-kind securities, including toggle notes, qualify for inclusion in the index. Callable perpetual securities qualify provided they are at least one year from the first call date. Fixed-to-floating rate securities also quality provided they are callable within the fixed rate period and are at least one year from the last call prior to the date the bond transitions from a fixed to a floating rate security. DRD-eligible and defaulted securities are excluded from the index.

HG1 Comdty
Copper Futures.

CL1 Comdty
WTI Crude Oil Futures.

S 1 Comdty
Soybeans Futures.

XAUUSD Curncy
Gold spot price quoted in USD.

The strategies described herein are speculative and entail substantial risks which may place your capital at risk. An investment in these strategies includes the risks inherent in an investment in securities, as well as specific risks associated with limited liquidity, the use of leverage, short sales, options, futures, derivative instruments, investments in non-US securities and illiquid investments. The Fund invests largely in other unregulated hedge funds. Such a portfolio of hedge funds may increase an investor’s volatility for potential losses or gains.

A particular manager of any strategy, from time to time, may invest a substantial portion of the assets managed in an industry sector. As a result, the manager’s investment portfolio may be subject to greater risk and volatility than if investments had been made in the securities of a broader range of issues. There can be no assurances that any particular strategy (hedging or otherwise) will be successful or that it will employ such strategies with respect to all or any portion of its portfolio. These strategies can be highly illiquid, are not required to provide periodic pricing or valuation to investors, and may involve complex tax strategies.

The strategies may be highly leveraged and the volatility of the price of its interests may be great. The fees and expenses charged by any individual manager of a strategy may substantially offset any trading profit.

The views expressed are as of February 2021 and are a general guide to the views of UBS Hedge Fund Solutions LLC (HFS), a division within UBS Asset Management. This document does not replace portfolio and fund-specific materials. Commentary is at a macro or strategy level.

Please note that past performance is not a guide to the future. Potential for profit is accompanied by the possibility of loss. The value of investments and the income from them may go down as well as up and investors may not get back the original amount invested. This document is a marketing communication. Any market or investment views expressed are not intended to be investment research. The document has not been prepared in line with the requirements of any jurisdiction designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. The information contained in this document does not constitute a distribution, nor should it be considered a recommendation to purchase or sell any particular security or fund. The information and opinions contained in this document have been compiled or arrived at based upon information obtained from sources believed to be reliable and in good faith. All such information and opinions are subject to change without notice.

A number of the comments in this document are based on current expectations and are considered “forward-looking statements.” Actual future results, however, may prove to be different from expectations. The opinions expressed are a reflection of UBS Hedge Fund Solutions LLC’s best judgment at the time this document is compiled and any obligation to update or alter forward-looking statements as a result of new information, future events, or otherwise is disclaimed. Furthermore, these views are not intended to predict or guarantee the future performance of any individual security, asset class, and the markets generally, nor are they intended to predict the future performance of any UBS Hedge Fund Solutions LLC, portfolio or fund.

Except where otherwise indicated herein, the information provided herein is based on matters as they exist as of the date of preparation and not as of any future date, and will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing or changes occurring after the date hereof. Certain information contained in this presentation constitutes “forward-looking statements,” which can be identified by the use of forward-looking terminology such as “may,” “will,” “should,” “expect,” “anticipate,” “target,” “project,” “estimate,” “intend,” “continue,” or “believe,” or the negatives thereof of other variations thereon or comparable terminology. Due to various risks and uncertainty, actual events or results or the actual performance of a Fund may differ materially from those reflected or contemplated in such forward-looking statements.

PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.

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