Bernard Ahkong
O’Connor Head of Europe

The last two years have been very difficult for global equity long-short alpha strategies, compared to the previous decade. Dramatic shifts in the macroeconomic environment have challenged long-held microeconomic assumptions and global equity long-short strategies have struggled.

Inflation has moved up to levels not seen since the 1980s and central banks have aggressively tightened monetary policy. As a result, higher valued companies have been disproportionately impacted as they are typically the higher growth or higher quality companies that equity investors are positively biased towards. A sustained and persistent increase in interest rate volatility has also led to higher factor volatility, influencing equity prices more frequently and heavily, which is not something fundamental equity long-short managers are accustomed to.

'Chart 1' shows data from Morgan Stanley Prime Brokerage, illustrating the average global alpha generated by their hedge fund client base during the 2010-2020 period compared to 2021 and 2022 YTD.

Chart 1: Global alpha generated by hedge funds

Line chart showing the disparity in alpha generation between 2021, 2022 YTD and the combined average of 2010-2020.

The chart compares the average global alpha generated by Morgan Stanley Prime Brokerage’s hedge fund client base during 2021, 2022 YTD, compared to the average of the 2010-2020 period. It shows that the average global alpha generated is much lower over the past two years compared to the previous 10 years.

Cyclically, we could see some mean reversion from here given the scope for rate volatility to move lower from an elevated starting point. Historically, this has been positive for relative value long-short equity investing.

'Chart 2' shows the MOVE Index – which looks at near-term implied volatility across different US Treasury maturities – reached levels during October last seen during the global financial crisis of 2007-2008.

Chart 2: Rising bond market volatility

Line chart showing bond market volatility since 2006 to 2022 YTD. It shows that volatility spiked during the GFC, the COVID-19 pandemic and has risen in the last year due to inflation fears.

The chart shows bond market volatility since 2006 to 2022 YTD, reflected by the ICE MOVE index. It shows that volatility has risen to levels last seen during the COVID-19 pandemic and also during the GFC of 2007-2008.

Many inflation data points have surprised to the upside this year, leading the US Federal Reserve to hike interest rates aggressively and rate volatility to spike. However, regardless of your view on inflation and central bank policy from here, it is difficult to see rate volatility staying this elevated in 2023.

Something has changed structurally, though. Years of accommodative central bank policy and supportive demographics from emerging markets have led to a structurally low interest rate and inflation environment. This helped support a backdrop of backing high growth companies regardless of valuation, and arguably diluted the skillset of focusing on relative valuation and capital structure differences.

We believe that this potential new paradigm favors teams with: experience through past cycles; a focus on bottom-up fundamental analysis combined with a strong relative value framework; and collaboration between teams across asset classes. There are also areas with structural alpha tailwinds relating to regulatory, policy, geopolitical and thematic change, which relate less to variables like interest rates and inflation. These are areas like China, private credit, event-driven situations, energy transition and trade finance.

In China we see four supportive factors operating together – high retail participation, low institutional investor interest, low research analyst coverage relative to other major markets, and improving liquidity for institutional investors. We believe this will create a conducive environment for long-short investing regardless of the market environment.

Equity long-short alpha has indeed been more challenging of late, and will require capabilities that not all investors are equipped with. Yet there are cyclical and structural reasons for investors to be more constructive on the opportunity set as we move into 2023 and beyond.

About the author
  • Bernard Ahkong

    Co-CIO O'Connor Global Multi-Strategy Alpha

    Bernie Ahkong is Co-CIO of O'Connor Global Multi-Strategy Alpha and is based in London. Previously Bernie was an Equities Portfolio Manager at BlueCrest Capital in London and he has also held roles at Lehman Brothers and Credit Suisse. Prior to joining the financial industry, Bernie was an Officer in the Singapore Armed Forces. He is a graduate of the London School of Economics with a B.Sc. in Economics.

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