Investing in “3D”: Forces shaping alternatives opportunities in 2024

In the second half of the year, we expect that three key trends will continue to play out, with a range of investment implications: 

• Divergence — In a shift from the post-GFC environment, global economies are increasingly in different phases of the business cycle, resulting in varied monetary and fiscal policy regimes (e.g., rate cuts in Europe versus rate hikes in Japan).
• Disruption — Technological innovation (including artificial intelligence but also biotech and fintech) is shifting the landscape of winners and losers. 
• Dispersion — A less homogeneous macro and market environment is leading to greater differences in company results.

We think all of this adds up to an opportunity for active management, including in the liquid alternatives and hedge fund space. Specifically, we think investors should consider the following ideas:

Global macro investing — This may be a natural way to take advantage of divergence, as greater economic volatility (e.g., in growth and inflation), geopolitical uncertainty, and diverse policy paths and choices (monetary and fiscal) can create a more fertile opportunity set for macro-oriented strategies. Skilled macro managers may identify situations where asset prices do not reflect economic reality, whether in rates, currency, credit, or other markets. Macro strategies may also be a source of diversification. Thanks to their flexibility (e.g., ability to go long and short in virtually all areas of liquid public markets), they may be able to take advantage of an environment in which other assets will struggle. (Learn more about macro investing in our recent podcast.)

Extension strategies — Often referred to as 130/30 or 140/40 strategies, extension strategies may be an effective way to add value in a market landscape where AI disruption is driving extreme levels of concentration in global equity markets. As of March 2024, about 86% of the stocks in the MSCI World Index had weights of less than 10 bps in the benchmark, making it difficult for long-only managers to add to their preferred stocks without being materially underweight the mega caps, which can introduce unintended risks. But with their ability to short stocks, managers of extension strategies have the flexibility to overweight the stocks they favor without having to underweight (on average) the largest names in the index to source capital. 

Long/short plays on sectors — A long/short approach may allow investors to profit from dispersion as market conditions increasingly separate winning companies from losing ones. The dispersion may be most acute in sectors undergoing rapid transformation, such as energy and financials. For example, our Financials team has highlighted that sector as an area with evidence of dispersion — e.g., between large-cap banks with strong financials and an improving regulatory outlook and regional banks facing a more challenging regulatory environment. Notably, many sectors exhibiting dispersion fall into the “value” universe today, and some investors might be hesitant to take on too much of a style tilt — another potential argument for a long/short approach. 

Long/short plays on regional opportunities — Higher dispersion in the performance of companies across regions or countries may also create attractive opportunities. For example, some of our equity investors have highlighted structural shifts in Europe that are likely to leave certain countries and companies better off than others. With the shift toward deglobalization, countries and companies that can pivot toward domestic growth may have an advantage over those that are export-led. Or consider fiscal policy: In a region as diverse as Europe, political and economic issues will vary greatly across countries, creating differences in fiscal stimulus that will impact sectors and countries in distinct ways.

Opportunistic and tactical ideas — With increased economic and policy volatility, we see the potential for more frequent market dislocations (a fourth “D”!). To take advantage of this, some asset owners are seeking access to finite-life tactical and co-invest opportunities that emerge from alternatives partners they know well. They may be able to more precisely match complementary opportunities given the various time horizons, expected return and risk parameters, and underlying liquidity features of these “trades.”  

Final thoughts on hedge fund roles and multi-strategy approaches

Ultimately, one of the most important steps asset owners can take when it comes to alternatives is to select strategies that truly fit the desired role. Our team recently wrote about a simple and intuitive framework for choosing and combining hedge funds in a way that creates strong alignment with one or more of four portfolio objectives: return enhancement, return consistency, diversification, and downside protection. Along with choosing individual hedge funds, asset owners may find that multi-strategy hedge funds can offer a variety of benefits, including diversified exposure to different strategy types and the potential for a more stable risk and return profile. You can learn more in our article, “Can hedge funds play the role?”.

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