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London (CNN Business)For years, the climate for hedge funds was tough. Volatility was low. The price of everything was going up. It wasn’t that hard to make money. In that type of environment, why think outside the box?
But as central banks continue with their aggressive campaign of interest rate hikes aimed at bringing down inflation, sending markets on a roller coaster ride, alternative strategies are getting another look.
“Certain hedge fund strategies can perform well in volatile and sideways-moving markets, an environment we expect to last into next year,” Mark Haefele, chief investment officer at UBS Global Wealth Management, told clients on Tuesday.
On the heels of a summertime rally, markets have started to churn again. Concerns have ramped up ahead of the Federal Reserve meeting on Tuesday and Wednesday, at which the only debate will be over how much to hike rates.
The S&P 500 just logged its worst week since June. Government bonds are also experiencing a steep sell-off. The yield on the benchmark 10-year US Treasury, which moves opposite prices, reached its highest in more than a decade on Monday.
No matter what the Fed announces tomorrow, uncertainty is likely to linger, given the central bank’s emphasis that it intends to keep making decisions on a meeting-by-meeting basis.
“Volatility is going to be the dominant theme through the back half of the year, largely because central banks remain data dependent,” Laura Cooper, senior macro investment strategist at BlackRock, told me.
That’s boosting interest in hedge funds, through which professional investors try to beat the market by deploying less-conventional approaches.
These funds struggled in the wake of the global financial crisis. Low interest rates and a period of relative calm in markets limited opportunities for contrarians. Now, they have an opening again — and some are finding success.
Hedge fund performance improved in August even as the stock market fell, according to the latest reading of the HFRI 500 Fund Weighted Composite Index, which tracks the top funds in the industry.
Not all types of funds are created equal. One standout has been macro funds, which look to take advantage of political and economic volatility. That category is up 14.8% year-to-date, while the S&P 500 fell 17% through August.
Investors trying to capitalize on turmoil in commodity markets have done particularly well, according to Robert Sears, chief investment officer at Capital Generation Partners, which invests in hedge funds for wealthy families.
Additionally, there are opportunities for stock picking, with some companies set up better to weather high inflation and an economic downturn. In recent days, warnings from companies including Ford (F) and FedEx (FDX) have sparked concerns that a wave of earnings downgrades could loom.
“Until we get into the cycle of earnings going down and the Federal Reserve starting to ease policy, really you’re set for an environment when hedge funds should do quite well,” Sears told me.
How HSBC’s wealth chief suggests protecting your portfolio
Not everyone wants to take greater risks. Nuno Matos, HSBC’s CEO of wealth and personal banking, has noticed an important change among his clients.
Global investors are “not being as active as they used to be,” with many looking to buy “more protection for their portfolios,” Matos said in an interview on Monday with my CNN Business colleague Michelle Toh.
“We see customers sitting a little bit in the sidelines,” Matos said, adding that many had turned to bonds as they search for some “stability.”
Matos shared how Europe’s biggest bank is advising its customers, which include both high-net-worth and retail investors.
For starters, diversification is now not just nice to have but “mandatory,” the executive said.
That’s not all: He also suggested investors explore “value” stocks versus “growth” stocks, essentially prioritizing big companies with stable market share and healthy payouts for shareholders over other fast-growing businesses.
Even as many people sell assets, “you want to keep invested,” said Matos, noting the adverse consequences of retaining cash during a period of high inflation.
The banker also said his team was bullish on the strength of the US dollar, partly because it felt the American economy had been “weathering the storm better than, for example, the European economy.” The US dollar has soared to its highest level in 20 years while many other currencies have tumbled.
How long will it last? Matos anticipates the current holding pattern among investors will stretch until the middle of next year, when markets have a better grasp of how interest rates will stabilize and get “some breathing space.”
Let the interest rate hikes begin
Sweden kicked off a pivotal week of central bank decisions with a surprisingly large interest rate hike, setting the tone for imminent announcements from the Federal Reserve, the Bank of England, the Bank of Japan, the Swiss National Bank and Norway’s Norges Bank.
This just in: The Riksbank on Tuesday raised rates by a full percentage point to 1.75%, part of a bid to slow price increases. Inflation in the country climbed to 9% in August.
“Inflation is too high. It is undermining households’ purchasing power and making it more difficult for both companies and households to plan their finances,” the central bank said in a statement. “Monetary policy now needs to be tightened further to bring inflation back to the target.”
Why it matters: The European Central Bank, a peer of the Riksbank, increased rates by three-quarters of a percentage point earlier this month. Since then, however, concerns that inflation remains stubbornly high have been working their way through financial markets.
Investors see an 80% probability that the Fed will hike interest rates by three-quarters of a percentage point on Wednesday. But after data showed last week that inflation rose more than expected in August, they’re leaving some room for a full-point move.
US housing starts and building permits for August post at 8:30 a.m. ET. Stitch Fix (SFIX) reports results after US markets close.
Coming tomorrow: It’s all about the Federal Reserve’s latest policy decision.
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