K2 Hedge-Fund Strategy Outlook: First Quarter 2022

With both the pandemic and inflation proving longer lasting than many had anticipated, what does that mean for central bank policy in the months ahead? The K2 Advisors team ponders the implications for hedge-fund strategies in its first-quarter 2022 outlook.

First Quarter (Q1) 2022 Outlook: Summary

As we commence 2022, the prospect of a reduction of global liquidity provided by major central banks has increased volatility in the traditional equity and fixed income markets. To complicate matters, inflationary pressures have been building and may not prove to be as “transitory” as once thought. Investors are looking to hedge funds to reduce volatility and increase flexibility in their overall portfolio, giving them optionality as markets transition to a new regime.

Strategy Highlights

  1. Relative Value: Observed continuing increase in dispersion within and across asset classes indicative of a potential increase in fundamental and macro risks and is favorable for less directional relative value strategies.
  2. Global Macro: A shift in policy regime may create market opportunities for managers focused on macro factors. Managers with a tactical trading approach may benefit from higher realized volatility across asset classes.
  3. Commodities: The major unknown is the Omicron variant and the subsequent impact on demand going forward, particularly in the energy sector. This should provide a rich opportunity set on both the long and short sides for active commodity traders.

Macro Themes We Are Discussing

As market volatility has increased, we have correspondingly seen a rise in dispersion among hedge fund managers. Event-driven strategies have been outperforming due to the number of deals, easy lending conditions, strong earnings, and companies’ strategic focus on future growth. Commodities mangers have also been consistently strong year to date (YTD), as not only have there been many large directional moves, but also rich relative value opportunities in the energy and grains markets. Global macro hedge funds have been challenged, as some common themes at the start of the year have not played out as planned, such as the steepening yield curve theme and weakness in the US dollar. Managers with more of a focus on developed markets have fared better than managers focused on non-developed markets. As expected, managers with an exposure to the energy, decarbonization and commodity markets have fared better. Credit managers have faced a challenge of extremely tight spreads but have been more focused on fundamentals and corporate specific events to generate solid returns so far. Long/short equity managers found the ability to generate alpha very challenging, particularly early in the year, but have shown recent signs of alpha generation as fundamentals are becoming more important than the global liquidity flows.