With a few exceptions, the hedge-fund industry had a year to forget in 2022, delivering negative returns to investors overall. Moreover, some players that focused on equities chalked up significant losses. But many analysts are tipping the industry to do well this year, led once again by macro strategies.
Could the hedge-fund industry’s fortunes improve in 2023?
Overall, hedge funds outperformed bond and stock indices in 2022. Yet the industry delivered negative returns, with the average hedge fund losing 4.2% over the year, according to Hedge Fund Research (HFR). 1 Some sectors fared even worse. US equity hedge funds, for example, lost 10.37% – albeit beating the S&P 500, which fell by 19.4% during its worst year since 2008. Event-driven hedge funds (including those that take positions on company mergers or restructurings) and relative value funds (which trade on asset-price dislocations) ended the year with losses of 5.04% and 0.9%, respectively. 2
Moreover, the industry-wide figures mask significant losses at some hedge funds that had performed well as tech stocks surged during the pandemic, according to Bloomberg. The agency reports that Light Street, Whale Rock Capital Management, Tiger Global Management and Perceptive Advisors each posted declines of more than 40% during the last two years. Bloomberg added that ‘those losses could prove problematic for smaller firms, given that investors pay lower or no fees on gains until they’re made whole’.
The problems stem from the pickup in inflation in late 2021, when tech shares on which players had focussed heavily, including the likes of Facebook and Tesla, nosedived. Few funds, according to Bloomberg, increased their short positions to take advantage of the fall. 3
Unsurprisingly against this background, new hedge-fund launches fell to their lowest levels since the global financial crisis in the third quarter of 2022. Not only did volatile markets create challenging conditions, but investors became more cautious, preferring to focus on well-established funds, according to HFR. 4
Hedge fund performance 2022
Brighter days ahead?
The global economy looks set to avoid recession in 2023, according to the International Monetary Fund (IMF), and inflation – and hence interest rates – are expected to peak and likely fall later this year. Consequently, there are reasons to believe that the conditions for the hedge-fund industry are brightening. That is certainly the view of Franklin Templeton. Its Hedge Fund Strategy Outlook Q1 2023, published in January, predicts that the first half of 2023 will be choppy as markets process inflation data, while central banks should moderate interest-rate hikes later in the year, inducing a sustainable risk-asset rally.
Franklin Templeton adds that ‘with the timing of these events being fluid’, volatility will remain high, ‘and market moves fleeting in duration early in the year’. It believes the environment will present ‘a rich opportunity set for tactical managers focused on security selection’. 5
Meanwhile, a Reuters survey of hedge-fund managers in early 2023 found that many were preparing for persistent inflation by gaining exposure to commodities and bonds that perform well in such an environment. Their other favoured instruments included ‘inflation-linked bonds to shield against price rises and selective exposure to corporate credit, as higher interest rates restore some differentiation in company bond spreads’. 6
Many funds, scarred by two years of losses, have sought to avoid equities. But that strategy came back to bite them as stock markets lifted early in 2023. Highlighting the risks posed by uncertainty over the path of interest rates, many funds scrambled to cover short positions in February. This was after the US Federal Reserve (the Fed) slowed the pace of interest-rate hikes and markets anticipated that borrowing costs would peak soon. 7
Can lightning strike twice?
Macro funds, which focus on economic trends and dislocations across asset classes, were the best performers last year – with some posting double- or even triple-digit gains . And many investors believe the strategy will do well again this year, according to Bloomberg. The agency cited a Preqin survey of allocation plans for 2023.
Macro strategies favoured to fare well again in 2023
Bloomberg believes that conditions could favour macro funds again this year. The agency argues they will benefit once again, this time by focusing on the Fed reversing the rate-hiking cycle in the second half of the year and the dollar declining in value. That view is based on the assumption that the frictions in the global economy – including a loss of authority by some of the major central banks that helped these strategies profit last year – are here to stay.
1 https://www.reuters.com/business/citadel-gains-january-leading-early-2023-hedge-fund-industry-returns-2023-02-06/
2 https://www.reuters.com/business/finance/hedge-funds-2022-post-worst-performance-since-2018-dragged-down-by-equities-hfr-2023-01-09/
3 https://www.bloomberg.com/news/articles/2022-12-28/stock-hedge-funds-vaporize-billions-with-another-year-of-losses
4 https://www.irmagazine.com/shareholder-targeting-id/new-hedge-fund-launches-slip-2008-levels
5 https://www.ftinstitutionalemea.com/articles/hfso/hedge-fund-strategy-outlook
6 https://www.reuters.com/markets/global-hedge-funds-plan-2023-around-inflation-risk-2023-01-04/
7 https://www.reuters.com/business/finance/hedge-funds-caught-bigger-squeeze-than-2021-meme-stock-frenzy-goldman-sachs-note-2023-02-06/
8 https://www.reuters.com/markets/macro-hedge-funds-end-2022-high-many-others-lose-big-investors-say-2023-01-10/
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