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What's next with hedge funds in 2025? · UBS Trending

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  After a decade of being overshadowed by passive investing, hedge
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  funds are showing signs of a renaissance.
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  They outperformed in the fourth quarter of last year, provided
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  better diversification than bonds, and now institutional sentiment is increasingly
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  bullish.
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  So is smart money rediscovering active management?
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  We're going to talk about that and more right now
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  on UBS Trending.
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  Hi, everyone, and thank you for joining me.
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  I'm Anthony Pastore, and this is another episode of UBS
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  Trending.
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  Here in the studio with me today is hedge fund
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  strategist from the Chief Investment Office here at UBS, Sean
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  Sanborn.
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  Sean, good to have you back with me.
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  Thank you for having me.
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  Anthony yeah.
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  You know, and it's, it's, it's really, look, when we
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  talk about hedge funds, we talk about alternative investments in
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  general.
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  It's a really interesting and very compelling story.
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  But specifically with the hedge fund story, I want you
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  to start off by just taking us through how they
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  fared in 2020, 24, and specifically how they performed relative
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  to bonds and stocks, which we talk about on this
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  show ad nauseam.
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  So people are very familiar with how performance has been,
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  especially with equities the last two years with 20% plus
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  returns two years in a row.
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  Bonds had a crazy year.
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  How did hedge funds do?
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  Yeah.
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  And then thank you again for having me.
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  It's definitely been a very strong year for for hedge
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  funds.
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  But I think taking a step back and looking at
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  kind of the broader context when you're talking about 2022-2023,
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  2024, yes, equities have rallied call it 656770 plus percent
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  over the past two years, especially from the drawdown seen
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  in the third quarter of 2022.
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  Hedge funds have still fared very well, returning kind of
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  around 35% during that that same time frame from the
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  from an equity drawdown, much higher than their overall overall
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  long term upside equity capture.
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  And doing that with a very strong return, especially in
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  the context of how bonds performed where they've been very
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  choppy and muted, as well as the equity bond correlation
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  is has been kind of stable or excuse me, unstable
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  and, and for the most part positive.
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  So hedge funds have been definitely giving you a larger
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  bang for your buck, just not only from an absolute
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  return perspective, but also from a diversification perspective compared to
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  bonds.
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  And then when kind of digging into overall kind of
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  alpha, what we saw was pretty strong alpha just across
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  the board from all main strategies.
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  We saw very strong alpha from long short equity, where
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  shorting came back with a pretty strong vengeance.
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  We saw strong alpha in both cyclical and offensive sectors,
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  but we also also saw very robust long alpha where
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  managers were largely kind of riding the AI theme.
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  And we're overweight magnificent 7 stocks for the majority of
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  2024.
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  But we also did see from where less directional strategies,
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  strong alpha within like relative value where we saw kind
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  of managers extracting carry and just kind of riding mark
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  to market gains and spreads tightened in a classic bevy
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  of relative value trades, call it fixed income, relative value,
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  convertible arbitrage, corporate credit and structured credits, really the whole
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  bevy of fixed income.
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  Yeah, it's like a full, a full like Cheesecake Factory
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  menu of options.
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  You know, I, I wanted to just kind of before
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  I we bury the lead, the outlook for CIO, which
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  I know you'll get into is remaining constructive on more
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  uncorrelated and relative value strategies.
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  But also you've gained conviction on some of the directional
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  strategies like those long shorts you were talking about some
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  Special Situations.
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  So now that we've got that out there, give us
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  a little bit of a flavor of some of the
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  risk taking that's happening across the strategies for the for
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  the for 2025, especially if there's any noticeable trends that
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  you've seen in the markets or anything that you're seeing
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  at the moment within the hedge fund space?
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  I think kind of the main take away that we're
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  seeing is really across the whole hedge fund spectrum, managers
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  are largely fading beta in favor of alpha kind of
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  an alternative risk premium exposures.
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  So when we're looking at even at just the index
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  level across kind of all the various HFRI index strategies,
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  we're seeing much lower beta exposures than kind of their
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  long term historical averages.
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  And this is also just kind of should be noted
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  at the index level where these are kind of probably
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  over diversified products where each individual underlying category index has
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  over 100 funds.
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  And then the fun way to composite is over 1000
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  funds.
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  And when you're running a kind of some form of
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  regression or any kind of analyzation of that return stream,
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  you're kind of essentially diversifying away alpha in favor of
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  beta.
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  So when we're speaking with individual hedge fund managers or
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  just doing some form of analysis at the median hedge
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  fund level, we're seeing even lower level of beta exposures
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  like an equity long short, we're seeing very almost close
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  to historical highs from gross exposure levels.
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  But then even that's are kind of closer to median
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  exposures.
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  And when you're beta adjusting exposures, they're even lower.
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  So we're seeing especially in the long short space managers
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  really kind of taking more kind of alpha oriented risk
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  and and looking at kind of maybe taking some some
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  higher quality quality or kind of growth at a reasonable
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  price exposures.
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  And that's the case for for most strategies as well.
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  Within macro, we're seeing them tackling trading around equity, but
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  for the most part they're going into kind of more
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  different areas, call it trading around currencies, riding kind of
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  US steepeners and just outright front short US bonds and
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  trading around kind of currencies Japan and the exposure's.
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  And managers were reducing risk in the back half or
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  maybe the last three or four months of 2024 from
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  what we could see as far as you know when
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  you look at what they're doing and as you talked
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  about in a recent report, kind of a function, sort
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  of a function of locking in profits and deploying cash.
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  So does that, does that affect what we see today
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  as what the expectation is for the rest of this
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  year?
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  I mean, I think that's a function just as as
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  how high uncertainty and dispersion and volatility is in the
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  market.
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  I think people's and relative value definitely we did see
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  a lot of managers take profits, just lock in gains
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  and are more comfortable just sitting on higher cash balances
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  waiting for some level of dislocation.
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  And that's really the main case for a lot of
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  the overall kind of hedge fund strategies that we're seeing.
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  It's just volatility is high, dispersion is high, and looking
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  to for any kind of short term dislocations they can
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  take advantage of, right?
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  What about if you look at overall investor sentiment, especially
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  from an institutional perspective, What, what, what, what were you
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  seeing when it came to some of these surveys that
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  were out about hedge fund and hedge fund investing in
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  the markets overall?
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  Yeah, hedge funds may finally be back.
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  It's it's interesting to say we're kind of privates have
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  definitely been the the hot asset class in the alternatives
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  landscape for a very long time.
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  What we're seeing from institutional surveys now is hedge funds
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  are on top of people's minds, even eclipsing private credit
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  where we've seen very strong inflows for the majority of
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  2024.
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  And on.
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  When looking at a lot of these surveys, call it
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  probably half of institutional respondents are saying that they're planning
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  to increase their over allocations another quarter or keeping allocations
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  stable or maybe looking for some shift in marketing dynamics
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  to potentially allocate.
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  And then only that kind of final quarter are looking
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  to decrease their over allocations and that's largely a function
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  of specific funds kind of not reaching their expectations as
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  opposed to just an overall kind of negative view on
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  asset class.
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  Right.
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  It really does say a lot about the asset class
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  itself that institutional investors are really putting their money to
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  work in this in the space.
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  And it kind of does throw away that as we've
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  been talking about for a while now, that traditional 6040
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  equity to bond ratio for most portfolios where you now
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  allocate alternative investments including hedge funds in there.
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  So let me just kind of then talk to you
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  then and wrap it up about what the outlook is
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  kind of gone into a little bit.
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  And you did say there were like lots of gains
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  and lots of success that was happening in the hedge
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  fund space.
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  Does it leave a lot of room for people to
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  get in?
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  Is it still a great investment opportunity as it sits
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  today when we look at 2025 and especially with a
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  lot of the unknowns that are happening with policy, with
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  what the Fed will do, What are your thoughts on
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  that?
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  I mean, it's hard, right?
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  It's, it's been 2 very strong years for hedge funds
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  to look at kind of the past three years, especially
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  from a risk adjusted return perspective, hedge funds of even
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  from a just a strategy perspective of being the lion's
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  share of most passive assets.
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  I think probably US large caps The only exception.
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  But if you look at the the structural tailwinds that
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  hedge funds have had kind of call it just higher
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  rates leads to higher cash balances and and better short
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  rebates that you're getting from like long short books as
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  well as kind of just the overall market dynamics.
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  We expect these to increase in 2025 and in some
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  instances or stay the same in 25 and in some
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  instances even intensify like you mentioned.
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  I mean we have a new presidential administration coming in
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  where it seems like there's just ever changing rhetoric and
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  just overall implementation on tariffs, fiscal policy and just immigration
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  policy.
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  You have diverging monetary policies as well as especially in
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  the US stickier and more stubborn inflation and there's kind
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  of been a, an extension of of or a pause
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  on the overall kind of Fed rate cuts.
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  You have very elevated equity valuations and I'd call it
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  top quartile, even top decile historical and and uneven body
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  yields.
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  These should all be factors that hedge funds should be
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  able to take advantage of.
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  And what we've seen is, is higher overall uncertainty, higher
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  dispersion, higher volatility.
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  We expect that to even ratchet up further.
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  Right.
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  It seems like they're able that managers, hedge fund managers
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  are able to deploy risk right now in the environment
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  that we're sitting in.
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  They are.
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  We've seen that so far in January.
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  Like for instance, we're we've seen discretionary macro managers that
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  have largely kind of been taking advantage of a lot
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  of this macro right volatility moving into kind of different
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  currency exposures, moving into less loved areas like European equities.
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  We're seeing different kind of event driven strategies taking advantage
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  of just the robust restructuring opportunity that we're seeing.
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  But we're also still seeing like certain strategies that are
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  kind of waiting for increases in volumes like merger arbitrage.
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  There's definitely been an increase in overall kind of corporate
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  settlement and on kind of potential MNA activity, but it
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  still hasn't necessarily come to the foreground.
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  So people are more just largely kind of happy at
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  least in that space just holding on to kind of
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  current risk and putting in a higher potential dealings, right,
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  just.
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  Holding on the couch, I mean it's exciting.
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  It's a really active market and there's a lot going
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  on.
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  And obviously we're telling our clients and advisors diversified portfolios,
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  especially in this environment where there are a lot of
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  unknowns ahead of us is really the right formula.
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  So including hedge funds and and privates in there as
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  part of analogy is certainly really helpful in that full
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  diversification kind of look, when you're looking at a portfolio,
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  diversification is key.
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  So thank you, Sean.
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  It's great to have you join us.
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  I think there's going to be a lot that's happening
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  within this particular space for the rest of the year.
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  So I'm sure we'll have you back.
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  Thanks for joining me.
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  Thank you for having me.
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  Good to see you.
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  Sean Sanborn again from the Chief Investment Office.
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  And for more information on anything that Sean and I
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  talked about today or anything else coming out of our
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  Chief Investment Office, visit our insights website at ubs.com/views.
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  Plus, you can also also follow UBS on social media
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  where all the channels like LinkedIn and Facebook,
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  you can follow UBS Trending at our Instagram page at
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  UBS Trending is the handle there.
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  And as always, if you have any questions about what
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  Sean and I spoke about today, make sure you are
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  chatting with your financial advisor.
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  Until next time, I'm Anthony Pastore.
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  We wish you a great rest of your day and
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  remember to keep your eyes on what's trending.
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  We'll see you soon, everybody.
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  Yeah.