Investors expect hedge funds to produce higher returns with the prospect of interest rates staying higher for longer, a BNP Paribas investor survey showed on Wednesday.
Interest rates in big developed economies have shot up since late 2021 to contain inflation, with resilience in the U.S. economy adding to a sense that rates will likely stay higher for longer than initially expected.
Investors now expect hedge funds to return an average of 9.75% annually within an average of 19 months, up from 6.85%, according to the survey.
However, hedge funds themselves think this will take longer, up to 29 months, the survey showed.
“There is a lag for hedge funds to catch up in the rising rate environment,” said Marlin Naidoo, global head of capital introduction at BNP Paribas.
“The question now is whether investors will be willing to wait - because that is where the gap is,” said Naidoo.
BNP Paribas said historical evidence shows hedge funds tend to perform well in higher and stable interest rate environments and less so when rates are lower.
When central banks are in a tightening or loosening cycle, hedge fund performance is not correlated to rising and falling rates, it added.
Stripping away the general rise in the MSCI index of world stocks, hedge funds posted on average a 1.10% better performance than three-month Treasury bills from January 2022 to August 2023, BNP Paribas said.
Only four of the central banks overseeing the 10 most heavily traded currencies held rate setting meetings in August. Until then, the total 2023 year-to-date tally for G10 central banks was 1,075 bps of tightening across 33 hikes.
Most of the hedge fund managers interviewed agreed with their investors about potential returns and 62% said they should outperform the risk-free rate by 6% or more.
Nearly half of the investors surveyed planned to move money to a different hedge fund strategy they thought would outperform in a higher rate environment.
The strategies of choice included systematically traded commodity trading advisors, corporate bond trading and actively managed macroeconomic portfolio trading.
Lacklustre returns might ultimately turn investors’ attention from the hedge fund industry to other kinds of investments considered alternative but with better performance, suggested family office investor Michael Oliver Weinberg.
“Even if hedge funds achieve a 10% net return with 5% returns on cash, that’s only a 5% return from risk. Whilst today one can get higher equity like returns with credit like risk from senior, covenant heavy, secured private credit and real estate,” said Weinberg.
U.S. stocks have surfed through multiple crosscurrents over the past week - from the blistering spike in Treasury yields to the Middle East shock at the weekend - but they remain on board amid what the IMF sees as “remarkable” U.S. economic strength.
With third-quarter earnings set to stream in later this week, Wall St stock indices hit their highest in almost three weeks on Monday having rallied back from early losses over the last two sessions. Stock futures are higher once again ahead of the bell today.
The initial market jolt from the weekend attacks on Israel seemed to dissipate quickly as a modest pop in oil prices levelled off far below recent highs. U.S. crude hovered just above $86 per barrel on Tuesday, still off almost 10% from the peaks of late September and down 5% year-on-year.
As cash Treasury markets returned from Monday’s Columbus Day holiday to a week of heavy long-term debt auctions, they were also greeted with rekindled optimism about the Federal Reserve’s policy rate trajectory.
Specifically, the typically hawkish Dallas Fed boss Lorie Logan suggested the recent tightening in bond markets may have done the Fed’s work for it and lessened the need for another policy rate hike. Fed futures tend to agree and now see only about a one-in-four chance of further rate rise.
“If long-term interest rates remain elevated because of higher term premiums, there may be less need to raise the fed funds rate,” said Logan, referring to creeping risk premia on holding long-term Treasury bonds.
Fed Vice Chair Philip Jefferson chimed: “I will remain cognizant of the tightening in financial conditions through higher bond yields and will keep that in mind as I assess the future path of policy”.
Ten-year U.S. Treasury yields are set to kick off Tuesday’s U.S. trading day at some 4.65% - almost a quarter of a percentage point below the peak set just after Friday’s blowout September jobs report.
It was that exceptional U.S. economic strength the International Monetary Fund spotlighted in its latest World Economic Outlook, released at the annual meetings of the IMF and World Bank in Marrakesh on Tuesday.
While the IMF cut its growth forecast for China and the euro area, it left its overall global forecast unchanged due to what it called the “remarkable strength” of the U.S. economy.
The Fund upgraded both its 2023 and 2024 U.S. growth forecasts by 0.3 and 0.5 percentage points respectively to 2.1% and 1.5% annual clips.
China’s ongoing struggles were amply illustrated by the latest worrying twist in its ongoing property bust on Tuesday - which saw its main benchmark stock indices fall again.
Country Garden extended losses and closed down over 10% after the embattled developer said it might not be able to meet all of its offshore payment obligations when due or within the relevant grace periods.
And once again reports suggest the Chinese fiscal policy response will be modest at best.
Bloomberg News reported on Tuesday that Beijing was looking to increase its budget deficit and is weighing the issuance of at least 1 trillion yuan ($137.1 billion) of additional sovereign debt for spending on infrastructure.
The after-hours report was enough to lift European infrastructure stocks, however, and the euro also got a lift. The dollar was easier more generally on the softer Fed view.
U.S.-listed shares of Chinese firms, including Alibaba Group Holding, JD.com and Baidu, rose between 1.1% and 2.4% ahead of the U.S. bell.
Elsewhere, PepsiCo edged 0.8% higher ahead of the beverage maker’s third-quarter results and Unity jumped 6.4% after the video-game software maker said its CEO John Riccitiello would retire.