The hedge fund trends for the rest of 2023 will be shaped beyond high inflation and an uncertain market, as machine learning takes hold of the industry. Fund managers must strategize accordingly.
At a time when the world - and the markets - were ready to move past COVID-19, another crisis couldn't wait to emerge: inflation.
And if that wasn’t enough, rapid and revolutionary advances in technology are fundamentally transforming the hedge fund management industry.
Combine that with a volatile environment and a more socially conscious populace, fund managers must rethink their strategies for investing and attracting clients.
Below are some of the trends to watch for the rest of the year.
Inflation is down from it 40-year high, but even at 5%, it's still too high for consumers' and investors' liking.
And with each rate hike comes increased risk of recession.
The markets took a beating in 2022 as a result of the inflationary climate, and sustained high rates will weaken the outlook for the rest of the 2023. Many investment firms, including hedge funds, have not been immune from the downturn.
That said, if there could be a winner in the hedge fund space, it’s global macro funds.
By definition, global macro hedge funds attempt to profit from wild swings in the market usually caused by political or economic events.
And there is no shortage of political and economic events.
Kenneth Tropin, chairman of Graham Capital Management, a macro-based hedge fund management company, has seen his macro funds perform very well compared to previous years.
This is what Mr. Tropin had to say about the current situation:
“I see this environment for what we do continuing to be fertile for a long time, not just a year, not just next year, but as far as I can see. Now that will end at some point, but I don’t see that ending anytime soon.”
And Jonathan Glidden, the CIO for Delta Airlines’ pension plans, had this to say about macro:
“Volatility is up significantly across most asset classes. We believe macro managers can benefit from micro-opportunities presented by investors’ reactions to economic, policy and geopolitical news in today’s volatile environment.”
Indeed, macro hedge funds are shining right now.
The State of Wisconsin Investment Board (SWIB), for example, has seen portfolio returns of 16.3% in the last year for its macro fund.
In light of the success, one of its portfolio managers, Derek Drummond, said that he “never” believed hedging should be their purpose and that global macro strategies are more of a way to diversify and add alpha overlay to a portfolio.
In the current climate, some hedge funds perform better (or worse) than others.
According to Institutional Investor, here are some of their findings:
Additionally, the top 50 hedge fund traders are off to a great start this year, and their portfolios are set to surpass benchmark returns once again.
And funds dedicated to certain sectors have seen their fortunes swell, notably in energy and commodities.
But international banks with fund exposure to Russian entities, they’ve lost out.
Other notables with big losses are tech-focused hedge funds, as gloomy economic data sparked selloffs.
The recent collapse of Silicon Valley Bank hasn't helped matters for hedge funds either.
Going in to 2023, hedge funds’ respective gains and losses look to continue.
"AI has the potential to fundamentally change the way investing works, and could solve a lot of the problems that have caused investors to lose money in the past."
For many, talk of AI has always felt like a distant, off-in-the-future thing, but not actively in the present. But that future is now, and the leading hedge fund managers are adopting machine learning.
According to a survey from hedge fund services provider Market Makers, 9 out of 10 ten hedge fund traders will use artificial intelligence to achieve portfolio returns. As interest rates have soared, even cash-rich investors have pulled back on risky human-powered trading and started in investing in AI
Leading firms like Jane Street, Barclays, HSBC, Apollo, and Bridgewater have begun using artificial intelligence to analyze trades.
Matt Forbes, an AI engineer, shared his take on machine learning for hedge funds:
"AI excels at one thing humans do poorly, that is pattern recognition. There would be no need to spend hours researching which currencies or stocks to trade. AI would decide everything for you, freeing up valuable time. It could also reduce any human biases in investing."
The collapse of FTX sent shockwaves through the entire crypto industry, and cryptocurrency total market capitalization fell under $800 billion, far below its peak of $3 trillion.
According to a PwC report, more than a third of hedge funds are invested in digital assets, and average allocation to digital assets increased from 4% to 3%.
While funds with exposure to Bitcoin have seen notable declines in their portfolio, it could always be worse.
One hedge fund admitted that half its capital was stuck on the FTX exchange!
While staying clear of crypto looks like a safe bet (or at the very least, don't put all your eggs in one basket), some hedge funds have a bullish outlook on crypto.
Man Group, a London-based investment firm with $183 billion in assets, is planning to launch a crypto-focused hedge fund.
And while crypto may be down, it’s not out, according to Bill Ackman, a hedge fund manager billionaire and CEO of Pershing Square Capital Management:
“I was initially a crypto skeptic, but after studying some of the more interesting crypto projects, I have come to believe that crypto can enable the formation of useful businesses and technologies that heretofore could not be created.”
With rising interest rates and the end of "cheap financing" with near-zero interest rates, the hedge fund industry is operating in a more challenging environment.
And by the end of 2022, new hedge fund launches fell to their lowest level since Q4 2008.
Despite the challenges, there was a slight uptick in Q4 2022 launches, there is an expectation that new launches will pick up this year, rebounding from historical lows in 2022.
Kenneth Heinz, President of Hedge Fund Research, shared his view on hedge funds and why they remain attractive to investors:
"The increase in launches and steady level of liquidations indicates institutions are increasing commitment to hedge funds, with institutions looking to pare back high beta equity and illiquid private equity holdings in favour of opportunistic, specialized, defensive portfolio positions. Despite the increase, launches for the full year 2022 remain near historical lows, and increased sensitivity to financial risk by institutions as a result of bank failures may contribute to a continuing challenging launch environment to begin 2023, despite strong performance through Q1 2023.
With a cautious, yet opportunistic, eye towards the risks and reward continuum looking into 2023, institutions are likely to increase their exposures to hedge funds, both established and newly launched, which have demonstrated their robustness through several recent years of dislocations and intense volatility across the range of asset classes.”
According to research from the Knight Foundation, only 1.4% of total US-based AUM was managed by diverse-owned firms in 2021, representing 0.4% growth from 2016.
And currently for hedge funds, 3.4% of US-based AUM is managed by minority-owned firms and 2.2% is managed by women.
And these numbers, small as they are, represent some progress, but not enough, according to investors.
Investors themselves are calling for improvements in DE&I (diversity, equity, & inclusion) for hedge funds.
According to a BNP Paribas study, investors are investing in women and minority-led funds 21% more than they were five years ago, with more growth for the future.
Indeed, hedge funds are starting to feel some “pressure” but in a good way, as there are benefits by focusing on DE&I and ESG.
Robert Howe, a principal at Mercer Advisors, shared his take:
“Just from a research point of view, cognitive diversity is great in an investment process. You have people from different backgrounds and with different mindsets who therefore challenge each other and ultimately make the better investment decisions.”
Jamie Kramer, head of alternatives solutions group at JP Morgan Asset Management, shared her view:
“If you tell hedge funds and institutional allocators that they’re missing out on superior returns and opportunities, purely because they’re not hiring from the biggest universes of talent, it could help to create this momentum and drive to invest in diverse fund managers.”
The 2% management fee of total assets and 20% fee for realized gains was a longtime industry standard, but that’s no longer the case.
According to Hedge Fund Research, in Q4 2020, hedge funds on average charged a 1.4% management fee and 16.4% performance fee. That is down from an average 1.6% and 19% a decade ago, respectively.
Fees on average may be lower, but that’s no reason to be discouraged.
Fund managers with solid track records can still command higher fees, and there is a lot of opportunity out there to raise assets and thrive in the current market.
Hedge funds can also find ways to cut costs and spend more time on revenue-generating activity, which will be explored in further detail in the outsourcing section below.
In addition to AI, think about other scenarios to get the most out of technology.
Having access to quality data and reporting is more important than ever, as well as having it right at your fingertips.
To stay competitive, hedge funds need to make full use of technology, optimizing efficiency in all processes:
When looking at specific ways to optimize in terms of technology, here are a few points to consider:
In addition, we help hedge funds automate their workflows, speeding up turnaround times, reduce errors, and cut costs.
Hedge fund managers can do a lot, but they can’t do it all by themselves.
With rising costs and falling fees, managing everything in-house puts an extra burden on hedge funds. Outsourcing is a way for hedge funds to relieve that burden.
According to speakers at a conference for HedgeweekLIVE North America, the pandemic lockdown accelerated the trend toward outsourcing for hedge funds.
Alex Prylucki, managing partner for the investment advisory consulting firm LEVVR, pointed out that the benefits of outsourcing are a lot greater than any one single individual a firm can hire.
He also added that with outsourcing, firms can take advantage of time zones difference for outsourced activity. For example, US hedge funds can have trade reconciliations done overnight by service providers in Asia.
At Empaxis, our hedge fund clients leverage us for overnight trade reconciliation, with the help of our dedicated team in Delhi and Kolkata. Clients really appreciate having reconciled reports first thing in the morning.
The hedge fund trends show a mix of opportunities and challenges that lie ahead. Hedge funds can be successful in 2023 by mitigating the risk when it comes to market volatility, cutting costs, leveraging tech and AI, and having a diversified portfolio.
By taking advantage of our outsourcing solutions, automation services, and TAMP1 platform, hedge funds can slash their costs while improving long-term overall efficiency.
As mentioned before, above hedge funds can do a lot, but they can't do it alone, nor should they. When it comes to those challenges, Empaxis has solutions.