Tailwinds From Rising Interest Rates, Volatility
September 2022
Liquid alternatives, broadly speaking, fared well on both an absolute and relative basis during August. The HFRX Global Hedge Fund Index, a representation of broad exposure to liquid alternative strategies, turned out a 0.9% monthly gain and is now lower by 3.6% year-to-date, easily outpacing the S&P 500 and Bloomberg U.S. Aggregate Bond Index during the month and year-to-date. August was a particularly good month for event driven strategies and trend following managed futures, both areas we continue to allocate to within our Diversified Strategies portfolios.
The HFRX Merger Arbitrage Index rose just shy of 1.4% during the month, while the HFRX Macro: Systematic Diversified CTA Index rebounded from a weak July, returning almost 3.2%. Both merger arbitrage and managed futures receive tailwinds from a rising fed funds rate as a higher risk-free interest rate boosts the collateral return component for managed futures strategies, and merger arbitrage strategies benefit from wider deal spreads as a higher risk-free rate leads investors to require a larger premium or required return to take on the risk of a merger or acquisition failing to close.
Amid a backdrop of elevated economic and geopolitical uncertainty, we expect volatility to persist over coming quarters, potentially benefitting trend following managed futures strategies as well as global macro managers, specifically. Both strategies tend to fare best during periods of rising volatility as a broader opportunity set allows them to quickly shift to take advantage of dislocations across global stocks, bonds, currencies, and commodity markets.
A challenging backdrop for investors in stocks and bonds is likely to persist over coming quarters and heightened volatility should drive dislocations and present opportunities for more flexible/nimble managers along the way. Additional portfolio diversification is likely to remain beneficial for portfolios of long-only stocks and bonds by ‘smoothing out the ride’ in the environment we expect.
Source: Hedge Fund Research (HFR)
