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In recent months, financial markets have faced significant turbulence. Relatively risky assets, particularly equities, have experienced double-digit declines. The S&P 500 Index, a proxy for US equities, is down more than 15% from its February 2025 highs, and many companies have seen even more substantial declines in valuations. This downturn has been accompanied by concerns about a growth rerating (lower), which has dealt a blow to market breadth — with many equity indices falling below their 200-day moving averages and recording lower lows in six out of the past seven weeks at the time of writing.1
Doubts about markets’ ability to hit growth expectations appears to be the force behind this bout of market volatility. This comes at a time when, in some cases, certain assets appeared to have been "priced to perfection." At the same time, other warning signs, such as weakening consumer data (e.g., credit card delinquencies) and decelerating earnings revisions, have been emerging. Additionally, the frenetic pace of new policies and actions taken by the new US administration, including “reciprocal” tariffs, questions over spending cuts and US deficit expansion, and immigration policies, could have added to investors’ anxiety.
Sticky inflation is also a prevailing market concern. The US Federal Reserve (Fed) and other central banks have indicated that they will have to contend with inflation despite growth risks. What’s more, geopolitical tensions around the world, including wars, elevated tensions in the Pacific, and rhetoric from the US administration about increasing its strategic presence in the Arctic, further exacerbate the situation. The combination of these factors elevates economic uncertainty. Were this to persist, risky assets may come under even further pressure (Figure 1).
Figure 1
The current market correction has raised several questions with short- and longer-term implications. Right now, investors may be asking: Is the correction over? But the current state of the markets prompts broader, longer-term questions, too. Will the US continue its exceptionalism and growth leadership among other major economies? Will the Fed and other central banks focus future policy actions primarily on growth (weakness) or inflation (stickiness)? Will investors begin to derisk in the face of recessionary fears?
The answers to these questions are mixed, but one thing is certain: Numerous structural forces, such as deglobalization, suggest that economic cycles will oscillate much more quickly through the growth and inflation quadrants, experience higher highs and lower lows, and push markets to extremes in some cases.
This correction reminds investors to revisit their capital market expectations and assess whether their current mix of asset allocations can conceivably achieve their objectives given still-elevated valuations and the factors driving uncertainty we explored above. One main conclusion from this may be that many portfolios could benefit from alternative sources of return and diversification. Specifically, diversifying hedge fund strategies have been a major topic of interest in recent discussions.
Importantly, we see strong economic reasons why many investors are either adding or considering adding diversifying strategies, such as hedge funds, to their existing portfolios. Conditions for delivering consistent, uncorrelated, alpha-centric returns have markedly improved while beta-centric returns, especially when adjusted for risk, are in decline. Elevated dispersion and macroeconomic volatility have contributed to these dynamics.
When equity markets fell in 2022, many investors realized bonds aren’t always an effective recessionary hedge especially in the face of rising and sticky inflation. Thus, finding strategies immune to duration risk that can still deliver the intended diversification benefits can be quite useful. Certain hedge fund strategies may fill this role and expand portfolio diversification effectively. This isn’t to say that fixed income shouldn't feature in a portfolio. It should, but we believe that given the return potential, investors may do well to find options to complement or diversify traditional fixed income.
Key to this is identifying what matters most across these two dimensions — offsetting potentially lower returns or adding protection at the (marginal) expense of some return. Regardless of where investors fall on the return/diversification continuum, we believe diversified, uncorrelated strategies, including multi-strategy and global macro, may be well-positioned to provide tangible benefits and should, in many cases, be a mainstay in investor portfolios, especially in this highly uncertain and turbulent environment we seem to have entered.
1April 7, 2025
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