Avoiding the distraction of ‘shiny things’ in prudent alternatives investing

Actively managed alternative investments, and hedge funds in particular have been enjoying a period of solid performance of late. Whilst the performance of all asset types unsurprisingly took a hit as the “black swan” of the COVID-19 pandemic hit all global markets, hedge funds have largely performed according to design since then.

As recovery from the global shocks comes at disparate speeds and with very specific asset pricing ramifications across economies, positioning at least a portion of risk assets into active management funds seems wise, and the ability to navigate environments in long/short fashion places hedge funds at an advantage over long-only active managers, and certainly over the passive fund/ETF universe.

Of course, any assessment of investment opportunity must be preceded by an educated, probability-weighted view of the current global investment landscape. Currently, this is a rather difficult task given all the global cross-currents as the world tries to emerge from the pandemic.

In March 2020, this dislocation was met with a wall of government-induced liquidity which has fueled an environment in which the price of many assets has risen relentlessly despite the global shock. This has led to valuations and market behavior that is disconnected from fundamentals. Notwithstanding some recent positive economic readings, especially from the US, the enormous size of the global liquidity response is the only explanatory bridge between value and current pricing and it begs the question of persistence.

This deluge of liquidity has clearly lifted all assets without the fundamental pillars required in the past. Once again, almost perversely, the result is that the best risk adjusted opportunities are to layer on prudent, uncorrelated strategies rather than assuming directional (read beta) risk in assets or strategies at arguably stretched valuations. This does not mean that an investor cannot have long-biased equity strategies, but simply that allocation to some non-correlated strategies should sit alongside these within a well-balanced portfolio. Strategies like global macro, advanced trend following, short-term trading, relative value volatility (including convertible arbitrage here), and other uncorrelated, preferably convex exposures all seem sensible at this juncture. Some exposure to commodities is desirable and for a geographic tilt, investment time spent on Asia, particularly Japan and China looks promising.

The fundamental challenge for investors when markets seem difficult to analyze and are in a liquidity-driven exuberant state, is to stay prudent and try to ensure a definable set of risk parameters governs. Appealing to investors’ theoretical sensibilities is effective in facilitating an audience to discuss adding uncorrelated exposures.

The difficulty lies in getting investors to allocate to these less sexy strategies, particularly as the “shiny things”, like growth equities, Bitcoin and SPACs command attention due to their return trajectory in this strange external liquidity-driven environment.

Jim Neumann

Neumann is chief investment officer at Sussex Partners. Prior to Sussex, he was founder and managing partner of BN Capital, a structured credit alternative asset manager. As part of that effort Neumann was also a board member, head of capital markets, and principal at Vendor Assistance Program, a FinTech firm providing funding to vendors getting paid late by US government entities (beginning with Illinois). Prior to that, he ran North Fork Capital, a hedge fund advisory firm after leaving Ramius Capital, where he was managing director and co-head of investments at Ramius Alternative Solutions LLC, which began as a joint venture between Ramius Capital Group and Unicredit/Hypovereinsbank (HVB). At Ramius he served on the Investment Management Committee and was also responsible for underlying manager selection, due diligence, and portfolio and risk management activities. Additionally, he was responsible for major institutional client relationships including a $1 billion co-managed fund with Unicredit/HVB. Prior to the joint partnership, he was managing director, CEO and CIO at HVB Alternative Advisors with similar duties, working on both the buy and sell sides of the securities industry for fifteen years, primarily in fixed income trading/portfolio management.
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