While some experts predict an economic slowdown, and analysts expect below-average returns, investors continue to seek opportunities that will help navigate market uncertainty. Moreover, and while global conflicts persist, almost half of the world's population will be electing political leaders throughout 2024. The outcomes of these elections will significantly impact world economies, depending on which direction they go.

In our latest outlook, we summarize the key drivers supporting our favorable outlook for the asset class – even in uncertain times – while further elaborating on the opportunity within sub-strategies.

Market outlook

We have once again not made any changes to our strategy outlook ratings as we still see compelling trading environments across hedge funds but Discretionary Macro, Fixed income: Sovereign, Fixed income: Asset-Backed, Fixed income: Corporate, and Volatility managers, particularly. The market/regime transition has taken hold leading to a drastic repositioning by investors and re-pricing of assets.

This global inflation theme continues to be the biggest factor impacting all strategies, creating a wide spectrum of opportunities for managers to trade. Discretionary macro managers should still be able to take advantage of global central banks and economies moving in different directions. While our relative value volatility focused managers continue to see a good opportunity set, although we are becoming cautious due to declines in both realized and implied volatility. Fixed income – sovereign managers are seeing wide dislocations, due to heightened interest rate volatility, but even if this volatility subsides managers should be able to capture a normalization of micro spreads. Despite remaining neutral on systematic macro strategies there are reasons to think that longer-term the environment is getting more attractive.

abrdn strategy ratings

Equity

We retain our neutral outlook for Equity Hedge, predicated primarily on an uncertain outlook for market beta. Certain indices, driven by the narrow leadership of a handful of mega-cap tech stocks, have performed well in 2023, but the broader performance of equities has been far more benign. Low index volatility belies a skittish market uncertain about the attractiveness of the asset class in the context of a confusing and increasingly bifurcated global macro backdrop. Regionally, Europe is likely to come under the most pressure, while the House View base case being the US will also suffer some form of (likely mild) recession at some point in 2024. The outlook for emerging markets equities is mixed, with some attractive upside optionality predicated on a potential economic and market recovery in China. Equities remain expensive on the whole (as measured by the ERP and headline valuations) and valuations will struggle to find support from here while recessionary risks loom large and the outlook for 2024 corporate earnings is murky.

As it is, we retain our positive outlook for Equity Market Neutral. The strategy should continue to be buoyed by (i) the prevailing long/short opportunity set predicated on a more discerning market in a tougher economic climate, and (ii) an improving relationship between stock prices and company fundamentals that will aid the realization of that long/short opportunity.

We continue to remain focused on diversification in our Equity Hedge allocations, across regions, sectors, and styles. The need for this is re-enforced by the extreme levels of concentration in crowded hedge fund names. Popular hedge fund names – long and short – have been performing well, as they’ve done historically over time, and this success is broadly symptomatic of the attractive stock-picking opportunity. Nevertheless, combined with a broader lack of bullish sentiment towards, and positioning in, equities, it poses rotational risk e.g., from seasonal platform trading or systematic de-grossing/profit taking. Our approach to building a diverse set of approved managers with uncorrelated alpha streams helps mitigate risks associated with rotations or market selloffs.

Event-driven

All five sub-strategies within Event-driven are remain rated neutral following the downgrade of Merger arbitrage. While forward-looking returns are supported by higher interest rates and wider spreads, the increasingly complex regulatory landscape is proving challenging to navigate for arbitrageurs and acquirers. Deal volumes are down amid higher financing costs, low business confidence, and higher regulatory risk though dry powder remains plentiful.

We do not expect the inherent beta tailwind to the strategy to be as prominent as it was in the 2019–2021 period. For this reason, and the potential associated trading illiquidity of an Activist position, we prefer Activist managers that apply some hedging and are not 100% exposed to equity markets.

Like the Activist strategy, Special Situations investing has a large beta component within its returns, and we do not expect it to be a tailwind ahead. We also generally moderate our outlook because Special Situations managers often target situations with softer catalysts that have a lower probability of occurring, and unlike Activist managers, are not trying to instigate change.

After downgrading the outlook during the previous review due to heightened uncertainty of regulatory intervention, we continue to temper our outlook because of a high degree of re-investment risk in the near-term. Many Merger Arbitrage managers enter year-end with lower invested levels after several large deal completions in H2 2023.

An allocation to Multi-Strategy can serve as a core holding in a portfolio because managers (a) focus on capital preservation and (b) have the flexibility to shift exposure between asset classes and strategies depending on the opportunity set quicker than we can. We can see this in our analysis which suggests Multi-Strategy returns are more sensitive to the underlying returns of Distressed and Merger Arbitrage strategies, in particular. This intuitively makes sense to us given these strategies can be more cyclical in nature. The underlying rating of each sub-strategy drives our decision to remain at neutral and all four have a neutral rating: Activist, Special Situations, Merger Arbitrage, and Multi-Strategy.

Macro

We continue to see a broad opportunity set for Discretionary Thematic Macro managers, which in the near term will continue to be driven by inflation dynamics and tight monetary policy. Macro managers, however, are starting to diverge in their views on the path for interest rates. Some managers remain convinced that the higher-for-longer interest rates policy will persist with no rate cuts delivered by the Fed in 2024. Others expect to see monetary easing starting as early as in 1Q24.

For Systematic Diversified Macro, we expect the softer period for quant macro traders to continue, as trends across different asset classes, which rewarded managers in recent years, are expected to remain weaker and sporadic, thus creating a more difficult environment for systems to monetize. We remain concerned about the short-lived risk-on rallies, plenty of examples of which we have seen in recent quarters prompted by a debt ceiling resolution, weaker monthly inflation prints, or the dovish Fed comments more recently.

Relative value

We continue to see dispersion across Fixed income: Sovereign instruments in developed markets, with G7 central banks having notably tightened monetary policy, persistent uncertainty on inflation and economic growth (and thus the future course of monetary policy), reduced liquidity and dealers’ ability to warehouse risk, as well as on-going geopolitical tensions. The combination of increased primary supply in 2024 in US and Europe, reduced dealers’ ability to warehouse risk, uncertain demand for US Treasuries from Japan as rates rise in Japan, and continued quantitative tightening in US/Europe/UK should keep dispersion high among fixed income securities and continue to generate an attractive opportunity set even if the overall level of interest rates volatility moderates as we head into a series of interest rate cuts in developed markets.

For Fixed income: Asset-Backed, we are generally constructive on the structured credit universe. While spreads across securitized credit assets are tighter than recent wides, they remain attractive.

For Fixed income: Corporate, we remain positive on performing credit strategies. While spreads have retraced relative to recent mid-October highs the yields continue to offer compelling returns, but security selection remains critical. All-in IG yields are at the highest since 2009 and spreads remain close to the post-GFC average. Credit duration is also likely to become more appealing as the in certain regions peak levels of interest rates are close and therefore the potential upside from lower rates is likely.

For Fixed income: Convertible Arbitrage, there are mixed signals across the convertible bond market, resulting in our net neutral score. Overall, Asia ex-Japan converts are viewed as cheap, while US, Europe, and Japan converts are rich. Compared with one year ago, convertible arbitrage strategies and other such as quality yield are viewed more favorably on a relative basis compared to busted converts.

While we continue to be positive on the outlook for relative value Volatility managers, our overall expectations for the strategy are slightly tempered. 2023 witnessed some strong downward trends in implied volatility levels, resulting in smaller relative value opportunities and muted overall performance for the peer group. With this lower starting point, spread opportunities have compressed, however, the very wide spectrum of potential outcomes being priced by the market does present the ability for more directional trades to have added convexity given the cheaper overall levels of implied volatility in certain asset classes. Interest rates is one area where implied volatility has remained high and will likely yield the most attractive relative value opportunities.

Important information

Discussion of individual securities above is for informational purposes only and not meant as a buy or sell recommendation nor as an indication of any holdings in our products. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of any mentioned securities.

Indexes are unmanaged and have been provided for comparison purposes only. No fees or expenses are reflected. You cannot invest directly in an index.

Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed, and actual events or results may differ materially.

Past performance is not an indication of future results.

Alternative investments involve specific risks that may be greater than those associated with traditional investments; are not suitable for all clients; and intended for experienced and sophisticated investors who meet specific suitability requirements and are willing to bear the high economic risks of the investment. Investments of this type may engage in speculative investment practices; carry additional risk of loss, including possibility of partial or total loss of invested capital, due to the nature and volatility of the underlying investments; and are generally considered to be illiquid due to restrictive repurchase procedures. These investments may also involve different regulatory and reporting requirements, complex tax structures, and delays in distributing important tax information.

Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).

Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.

Hedge funds use sophisticated investment strategies that may increase investment risk in your portfolio. Among the risks presented by hedge fund investments are: the use of unregistered investments, which may make it difficult to assess the performance of the holding; risky investment strategies, which may result in significant losses; illiquid investments that may be subject to restrictions on transferability and resale; and adverse tax consequences.

Investments in asset backed and mortgage-backed securities include additional risks that investors should be aware which include those associated with fixed income securities, as well as increased susceptibility to adverse economic developments.

AA-310124-173597-1