If one were to draw a planetary parallel to the chaos that central bank intervention has caused in global markets over the last five years, then Jupiter, and specifically its Great Red Spot, would be appropriate.
"Eight years after the financial crisis, the world suffers from a debt hangover. Globally we are approaching the limits of monetary policy and the battle of the balance sheet is now becoming the battle for the consumer – customisation is king," says KPMG's Anthony Cowell, when speaking to Hedgeweek at CAIS 2017.
Quantitative easing and a central bank obsession with supporting the global economy at all costs, in a desperate bid to drive inflation, has stripped volatility and made it increasingly difficult for equity market traders to generate alpha. Since mid-2012, the S&P 500 Index has nearly doubled in size.
Now, however, there are signs that global central bank monetary policy is diverging. "Janet Yellen has already said that she might increase the pace of monetary tightening. If that is the case, we know that central banks don't operate in an unconnected world so anything the US Federal Reserve does then has implications on what responses come out of the BoJ, the ECB and so on," remarks Tarun Ramadorai (pictured), Professor of Financial Economics at Imperial College London.
In his view, global macro strategies, when combined with a sensible risk overlay that can absorb whipsawing markets, might be a good option for investors to consider. "Global macro, in my view, simultaneously represents the greatest opportunity and risk for investors in 2017," he adds.
Hedge fund managers would welcome a period of central bank retrenchment as it would allow the markets to return to fundamentals and introduce more idiosyncratic risks into the global economy.
Geraldine Buckingham is Global Head of Strategy at BlackRock. She says that strong fundamentals "are driving our bullish view on European Equities. We believe both the uncertainty and scepticism about the upcoming elections in France and Germany have already been priced into the market.
"In the US, the Trump administration's proposed stimulus package supports our views of higher nominal growth and inflation. These themes support investments in cyclically oriented, value style equities such as financials and industrials. We are also encouraging investors to look at global inflation linked and short duration bonds for yield alongside downside protection."
In the US, the Fed is expected to raise rates three times in 2017, yet Buckingham believe rates will still remain low over the next few years. Because productivity and business investment is low, "We believe monetary policy will stay accommodative longer into this cycle than in previous recoveries. In this sort of low return environment, we see investors increasing their search for investments that provide higher, uncorrelated returns such as alternatives," comments Buckingham.
Political uncertainty is likely to be a significant driver of volatility in the markets, given that the French and German elections are looming and Italy could also go to the polls later in the year. Ramadorai believes this will have implications, even on strategies that are implemented for mean returns "because they will need to hedge against potential shocks to guard against political uncertainty.
"Consequently, risk management in hedge funds is going to be a big issue this year. Some interesting opportunities might arise if volatility is mispriced; options market strategies will likely come to the forefront and Market neutral and risk arbitrage strategies might appeal to investors. However, I think trend-following strategies (CTAs) are going to face some headwinds because I suspect markets will remain range-bound for a time," remarks Ramadorai.
A galactic nursery
William J. Kelly is CEO of CAIA. In his view, over the last few years the hedge fund industry has been a tale of two cities. The mainstream media are quick to report on the widespread disappointment of hedge fund returns, high-profile closures and so on, but there is a real clear disconnect, relative to what the actual industry reports.
He cites a recent report by AIMA and Preqin that looked at risk-adjusted returns and Sharpe ratios for hedge funds, and lo and behold they outperformed equities and fixed income, not only in 2016 but over three- and five-year periods, respectively.
"Equity markets have been fuelled by central bank intervention. This has inflated P/E ratios and it has driven certain expectations that hedge funds should be keeping pace when the opposite is true; these are uncorrelated return streams. I think there remains a lot of good opportunities, across many different risk premia, within the hedge fund space and with this run-up in equity valuations, I think now, more than ever, holding diversified portfolios is critical," says Kelly.
He adds: "The bulk of hedge fund assets, which represent about USD3 trillion of the USD8 trillion in total alternative assets – compared to USD100 trillion in global fund assets under management – have grown five or six times in size, compared to what they were 10 years ago so this is still quite a young industry."
Just as a galactic nursery is full of young stars growing and coalescing, the hedge fund industry has many more years to expand and evolve.
More broadly within alternatives, Buckingham says that BlackRock are especially bullish on Real Assets and Private Credit: "We view Emerging Markets as a long-term opportunity as fundamentals remain strong, and we see China as a growth leader among EM countries. We also believe unconstrained fixed income is more attractive in a rising rate environment for generating income.
"Lastly, Smart Beta products offer a compelling opportunity for investors looking for alternatives to traditional active. These strategies experienced USD55 billion of inflows globally in 2016, an 83% increase over the prior year," outlines Buckingham.
Artificial intelligence: A force for change
Aside from market forces, the threat to globalisation and geopolitical uncertainty, one aspect that is likely to play an increasingly role, as alternative fund managers seek to defy gravity and produce outsized returns for their investors, is the large-scale emergence of artificial intelligence. This is not to suggest that the machines will take over asset management, but as millennial investors become more prominent, meeting their expectations is, in many ways, a journey into the next frontier, for alternative managers large and small.
"The alternative investment industry has been locked in a digital wilderness for too long – sales and distribution networks are outdated and the way to stay relevant is as much about interaction with clients as it is about performance and product," asserts Cowell. "Defying gravity is recognising the exceptional times we live in and setting a course for success. We will begin to see managers adopt and explore new digital platforms that can reconfigure their traditional processes, robotic automation that optimises efficiency, cognitive technology and machine learning. These will be differentiators."
Challenging traditional views on how and where to allocate within the alternative funds industry will be crucial to elevating it to a new sphere of influence. For too long, there has been a lack of gender diversity, particularly within hedge funds where the vast majority are owned and led by males.
"I believe the benefits of gender diversity from a business perspective will be realised over time," comments Amanda Pullinger, CEO of 100 Women in Finance, which seeks to empower female finance professionals, advance their careers through education and inspire the next generation. "Various studies have shown that diverse teams do make more profitable companies, they do produce better returns and I have to believe that investors will become more focused on women-led hedge funds because it makes economic sense to do so. I think we are at the beginning stages of the conversation about this."
Demand is only half the story, however. It also comes down to supply. Who will be the next stars of the industry? Are there enough women-run hedge funds in the marketplace to inspire female graduates?
Pullinger concedes that millennial investors, who are far more attuned to gender equality, could be open to investing in female fund managers but the challenge is how to execute the plan. Often, Pullinger speaks to people within the industry who say that they can't find enough women in finance to recruit: be they portfolio managers, senior managers and so on.
"Whether millennials are more apt to take gender diversity more seriously (and they probably are) they've still got the challenge of finding good female hedge fund managers and that has to be addressed; both from the standpoint of female managers and how investors are sourcing those managers.
"We've been putting on female investment manager conferences. We've now done three conferences in San Francisco, two in New York and one in London and what we've heard throughout all those conferences from investors is: `These managers are superb. Why haven't we seen or heard of them before?'" remarks Pullinger.
Kelly says that it is vital the alternatives industry has a more diverse set of talented individuals in both junior and senior management positions: "We have to do a better job of this in our industry and if someone is looking to fill a board seat or a CEO role, it's important that there is a highly diverse and qualified set of people to choose from."
Visibility is an issue. Many female managers stay under the investor radar. Pullinger argues that, from an investor standpoint, they look for managers in the traditional way, using traditionally male networks where women don't feature. They fall in between the cracks.
To that end, it is also beholden on institutional investors, as well as investment managers, to defy gravity and re-think the way they source investment talent.
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