Macro trends to continue to dominate hedge-fund returns in 2023?

Hedge funds outperformed global equities by a wide margin in 2022, but delivered negative returns overall, and their performance was the worst since 2018. Aggregate returns fell by 4.25% over the year, as measured by the HFRI Fund Weighted Composite index, according to hedge-fund data specialist Hedge Fund Research (HFR) . Of the four broad hedge-fund indices, only the Macro index delivered positive returns – with an aggregate return of 9.3% over the 12-month period.

Of the other three indices, the HFRI Relative Value (total) fell by 0.9% over the year, the HFRI Event-Driven (total) declined by 5%, and the HFRI Equity Hedge Total lost 10.4%. Aggressive hikes in interest rates in response to higher inflation contributed to the losses in global equities, with the Morgan Stanley Capital International (MSCI) World Index down by more than 15% over the year. Most major markets suffered losses. Moreover, stocks saw considerable volatility in 2022 as investors tried to gauge the impact of conflicting data about the state of the economy on interest-rate expectations. Unexpected events such as Russia’s invasion of Ukraine further fuelled the turmoil in equities.

Upward trend in global interest rates to continue

Macro-focused strategies took advantage as central banks retreated from years of quantitative easing and attempted to rein in inflation by, for example, shorting rates in the US and other G7 countries. The upward cycle in interest rates may well continue for some time in 2023. There are signs that inflation has peaked in some economies, with certain analysts even warning that disinflation will emerge in 2023, but the major central banks have cautioned that they’ll continue to raise interest rates to prevent inflationary forces from gaining control.

The European Central Bank (ECB) warned in December that interest rates would still have to rise ‘significantly at a steady pace to reach levels that are sufficiently restrictive to ensure a timely return of inflation to the 2% medium-term target’.¹ At the end of 2022, the ECB forecast that eurozone headline inflation would average 6.3% in 2023 – way above the 2% target. Federal Reserve (Fed) officials have also indicated that more rate hikes can be expected, and that borrowing costs will remain elevated for some time.²

There have also been warnings that inflationary pressures could persist even as energy prices – one of the key drivers of inflation in 2022 – ease. The Bank of England (BoE) Chief Economist Huw Pill, for example, believes a tight labour market could offset the impact of falling gas prices, implying that further rate rises may be needed. A fall in the number of older workers in the workforce since the Covid-19 pandemic has contributed to labour shortages in the UK.³ But the country is far from alone in facing this challenge, with companies around the globe offering higher wages to attract and keep labour. At the end of 2022, for example, the US had ten million job vacancies but only around six million unemployed workers.⁴

The year of living dangerously

The scope for further geopolitical instability that could once again disrupt supply chains and force another spike in inflation is considerable. The war in Ukraine shows little sign of ending, while China continues to threaten Taiwan. Chinese officials, for example, have repeatedly reiterated their commitment to take Taiwan back. At the end of December, China sent a record 71 planes and seven ships towards Taiwan – the largest such exercise in 2022.⁵

Hedge funds in review

Global macro funds won in 2022 while stock-pickers disappointed