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ResearchThe Weekly (9/27)

The Weekly (9/27)

Oct 27, 2023

Since the economy embarked on a new cycle of post-Financial Crisis growth, financial markets have been relatively stable. The S&P 500 climbed higher from 2010 - 2020 and there was a point where you could simply throw a dart at the board and likely make money. The priority was growth and investors didn’t want to miss out. 

When rising tides lift all boats, the market environment was abysmal for market participants like hedge funds. Seeking returns that are uncorrelated to markets while keeping up with markets proved to be a difficult task. 

As indexes moved higher, hedge funds were a difficult sell. Investors began to question why they should be paying sky high fees for an investment that has consistently underperformed. As returns lagged the market, net asset growth for hedge funds (a measure of inflows) turned negative. In nearly every year since 2015, more funds closed than opened.

But a new regime is emerging.

Over the last 18 months, interest rates have moved higher and volatility has increased, an environment that is usually fruitful for active investors. 

As such, hedge funds have had a banner year. Net inflows have been higher every quarter throughout the year and assuming the pace continues, 2023 will be the best year for hedge funds since 2015. 

So what changed? 

It could be argued that the demand for hedge fund investing is a result of recency bias: Barclays Hedge Fund Index, which measures returns across the industry, net of fees, lost a mere 8% in 2022, while the S&P 500 lost nearly 18%. 

Or, in a more tactical perspective, could it be that investors are unconvinced that easy returns in the coming years are a sure thing? The aforementioned risks loom large and returns are still required even in times when markets aren’t going up and to the right. 

In volatile markets, hedge funds are oftentimes structured to outperform. The flow of capital out of traditional investments and towards more bespoke capital solutions could be a sign of expected volatility ahead. 

Beta, or market return, is often sufficient when a rising tide lifts all boats (a zero interest rate environment, for example). In the more traditional investing landscape like we’re now seeing, alpha is reemerging and it could be here to stay.

Have a great weekend,

Your Titan Team

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