Investing.com — Hedge funds have proven their worth in protecting portfolios during times of significant market volatility, as seen in August 2024.
UBS analysts pointed out in a note that hedge funds, especially those using non-directional strategies, benefited from market disruptions while protecting themselves from losses on stocks and bonds.
With continued market uncertainty, hedge funds are becoming increasingly important for managing risk, driving returns and dealing with unpredictable economic conditions.
Contrary to expectations of a quiet summer, August 2024 brought significant market turbulence. A combination of low liquidity, weak US economic data and geopolitical concerns led to increased volatility.
The volatility index soared and global stocks saw a sharp sell-off, with the US 60/40 portfolio falling 3.1% in just three days, UBS analysts said.
225 also saw a dramatic decline of 20%, underscoring the fragility of global markets.
“However, early August brought market jitters against a backdrop of low liquidity due to weak US jobs and manufacturing data, leading to concerns of a “hard landing,” the analysts said.
Deleveraging, especially in Japanese markets, exacerbated the situation and led to significant sell-offs across asset classes.
While traditional long-only portfolios suffered from increased correlations between stocks and bonds, hedge funds excelled in providing uncorrelated returns and taking advantage of the opportunities that volatility presented.
UBS notes that hedge funds with lower market exposure, including funds using equity market neutral and alternative credit strategies, performed significantly better during the market swings in August.
Convertible arbitrage strategies, which benefit from long volatility profiles, rose 1.1% in August as they benefited from sharp shifts in market sentiment.
Similarly, fixed income relative value strategies and credit hedges contributed positively, with UBS noting that many managers were able to cash in on gains from wider spreads before markets recovered.
Hedge funds not only provide downside protection, but also thrive in environments characterized by market dislocation.
UBS analysts emphasize that during periods of volatility, prices often deviate significantly from their intrinsic values, providing hedge fund managers with unique alpha opportunities.
By taking contrarian positions (buying undervalued assets or shorting overvalued securities), hedge funds can benefit if prices return to their natural averages once markets stabilize.
UBS points to the success of discretionary macro strategies, which weathered August’s turbulence by taking advantage of moves in global currency and bond markets.
One of the key advantages that hedge funds offer is their ability to provide uncorrelated returns during periods of market instability.
As correlations between asset classes rise during times of stress, portfolios that include traditional assets such as stocks and bonds become more vulnerable to simultaneous declines.
However, hedge funds are designed to exploit market inefficiencies and profit from price dislocations, rather than simply riding on broader market movements.
According to UBS, strategies such as global macro, stock market neutral and multi-strategy funds have been particularly effective at delivering uncorrelated returns, smoothing portfolio performance and reducing overall risk. These strategies allow investors to maintain their exposure to risky markets while mitigating the impact of sharp sell-offs.
UBS analysts expect continued volatility in the coming months as central banks adjust monetary policy and geopolitical risks remain high. While concerns about inflation have subsided, economic data continues to fluctuate and the path of future Federal Reserve rate cuts remains uncertain.
Meanwhile, the looming US presidential election is expected to create further political uncertainty, which could drive market fluctuations.
Given these factors, UBS recommends that investors incorporate hedge fund strategies into their portfolios to prepare for future volatility.
Low-net equity strategies, alternative credit funds, global macro funds and multi-strategy funds are seen as well positioned to help investors manage risks and seize opportunities as markets evolve.
While hedge funds offer significant opportunities, UBS also highlights the risks associated with these investments. Hedge funds are often illiquid and may require lengthy lock-up periods.
Furthermore, their strategies can be complex and investors must be prepared for potential losses, especially when leverage is used.
That’s why UBS urges investors to approach hedge fund investing within the context of a well-diversified portfolio and ensure they are comfortable with the risks involved.
