Q&A

Absolute Return Strategies – Navigating Market Turmoil

April 2022

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Past performance is not necessarily indicative of future results. No assurance can be given that any investment will achieve its given objectives or avoid losses. Unless apparent from context, all statements herein represent GCM Grosvenor’s opinion.

Select risks include: manager risk, macroeconomic risk, interest rate risk, strategy risk, mark-to-market risk and liquidity risks.

The world and investment landscape continue to evolve at a rapid pace. Below, we address some of our clients’ most-often asked questions regarding absolute return strategies in the current environment.

Q: The investment landscape has changed materially, and risk levels have increased meaningfully, first due to the pandemic, and now due to geopolitical turmoil. How do you expect absolute return strategies to navigate this new environment?

We recognize that the world is more complicated and volatile today than it has been in many years, and recent events have intensified the stress on investors. We have observed over many years, and strongly believe today, that the value of absolute return strategies and active management are greatest during times of rapid and extreme changes like those we are seeing.

For example, the ability for hedge fund investors to be nimble and responsive to the risks during the Covid-19 pandemic allowed many of them to avoid holding investments in businesses that proved to be structurally impaired, and take advantage of businesses whose growth would be accelerated. And today, amid the Russia-Ukraine conflict, rising interest rates, rising inflation, and elevated risk of recession, we believe actively managed absolute return strategies are well-positioned to withstand the tumultuous markets due to their ability to mitigate (and/or profit from) downside risks and avoid being in “stranded” assets.

In short, we believe turmoil can upend or exacerbate existing economic and behavioral trends in any environment, and absolute return strategies are built to adapt to changing conditions. Conversely, traditional long-only allocations and “autopilot” strategies have proven to be less resilient during such periods.

Covid-199 crisis, inflation, and war

One particularly risky aspect that has emerged from recent events has been the trend of “deglobalization” – the movement toward a more local supply chain at the expense of global trade. This shift toward the domestic production of goods and services is contributing to inflation by creating higher costs, and thus adversely affecting businesses and investments. These inflationary pressures are likely to persist (exacerbated by high energy costs) and investors should consider this new paradigm in adjusting their portfolio positioning. As discussed further below, we believe absolute return strategies are an effective tool for this purpose.

Q: Inflation and interest rates are both rising; how will this impact the various absolute return strategies and the opportunity set?

Both rising rates and rising inflation are typically headwinds for financial assets. Price/earnings ratios for stocks typically decline during such periods, while long-only fixed income investments struggle as rising rates impair the value of existing holdings. This has recently led to one of the worst fixed income drawdowns on record.

Historic downturns in fixed income

While absolute return strategies are not immune to broad market movements, the performance of such strategies has generally been better in higher rate environments than in low-rate ones, such as the near zero interest rate policy (ZIRP) environment we have experienced frequently since the GFC.

Zero interest rate policy and performance

The reasons for this improved performance are identifiable and consistent, and we believe will be similar as we go forward in 2022 and beyond:

  • Higher rates provide additional interest income and short rebates to most hedge fund strategies
  • Higher rates typically lead to increased volatility and dispersion in equity and credit markets, providing more fertile opportunities for long/short strategies
  • Higher rates often lead to higher corporate defaults in credit markets, enabling distressed securities focused managers to capitalize
  • Higher rates and volatility cause more frequent dislocations (in sectors, regions, or individual companies) and thus an improved opportunity set for hedge funds

Q: What are the most important trends you are seeing in the hedge fund industry?

We continue to see the resiliency of absolute return strategies, particularly regarding downside mitigation. In the last few market drawdowns, including the two highlighted below, these strategies have delivered on their value proposition to mitigate downside while capturing meaningful upside relative to long-only strategies.

Global Financial Crisis vs Covid-19 Pandemic

As a result, many institutional investors are increasing allocations to absolute return strategies. Industry assets climbed to an all-time high at the end of 2021, with over $4 trillion.[1] This level of investment bears-out the fact that that absolute return strategies are a global and robust industry.

Other trends we are seeing:

  • Despite the proliferation of assets, there is increasingly limited capacity among top managers, as investors place more value on accessing peak assets, and such managers remain disciplined around asset growth in seeking to preserve returns.

  • Hedge funds have become quite transparent. Today, investors can see through to their underlying positions and holdings in many funds like never before, and thus make better and more informed decisions.

  • The industry is stable. Banks with healthy balance sheets are providing financing (and leverage) with attractive terms to hedge funds, and high-quality managers have diversified their counter-party exposure.

  • Institutional-quality hedge funds are deploying robust risk management frameworks to measure, mitigate, and report key portfolio, operational, and tail risks. They are using sophisticated systems to monitor asset class and factor sensitivity, gross and net exposures, value at risk, leverage, and scenario analyses, especially potential impacts from extreme market movements.

For more about why we believe absolute return investments are particularly important components of a properly diversified portfolio, read the Case for ARS series.

For more on GCM Grosvenor’s absolute return strategies capabilities click here.

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Important Disclosures

For illustrative and discussion purposes only. 

No assurance can be given that any investment will achieve its objectives or avoid losses. Past performance is not necessarily indicative of future results.

The information and opinions expressed are as of the date set forth therein and may not be updated to reflect new information.

Investments in alternatives are speculative and involve substantial risk, including strategy risks, manager risks, market risks, and structural/ operational risks, and may result in the possible loss of your entire investment. Past performance is not necessarily indicative of future results. The views expressed are for informational purposes only and are not intended to serve as a forecast, a guarantee of future results, investment recommendations or an offer to buy or sell securities by GCM Grosvenor. All expressions of opinion are subject to change without notice in reaction to shifting market, economic, or political conditions. The investment strategies mentioned are not personalized to your financial circumstances or investment objectives, and differences in account size, the timing of transactions and market conditions prevailing at the time of investment may lead to different results. Certain information included herein may have been provided parties not affiliated with GCM Grosvenor. GCM Grosvenor has not independently verified such information and makes no representation or warranty as to its accuracy or completeness. 

Data sources

[1] Source: HFR, Inc., www.HFR.com

The HFRI Fund Weighted Composite Index is being used under license from HFR, Inc, which does not approve of or endorse any of the contents in this report.

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Absolute Return Strategies

We offer clients a broad range of tailored solutions across strategies, including multi-strategy, macro, relative value, long/short equity, quantitative strategies, and opportunistic credit. Levaraging our large scale and presence in the industry, we are able to offer clients preferntial exposure to hard-to-access managers and seek to obtain terms that can drive economic and structural advantages.