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Hedge Fund performance at times of Central Bank activism

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Monetary easing is upon us. Today, we take a deep dive into what this means for hedge fund performance. 

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Hedge Fund performance at times of Central Bank activism

Monetary easing is upon us. Today, we take a deep dive into what this means for hedge fund performance. 

At the ECB’s most recent meeting, the central bank took decisive steps towards easing monetary conditions later this year. Recent surveys have implied that the contraction in manufacturing activity in the euro area is worsening and inflation expectations have been revised down further. Critically, the ECB stated that it is “examining options for the size and composition of potential new net asset purchases.” In coming days, the Federal Reserve is set to cut rates for the first time in a decade. We believe the Fed will not hesitate to re-launch asset purchases if needed.

Monetary easing has huge implications for asset prices and fund performance by extension. By focusing on hedge fund performance during the Fed’s quantitative easing (QE) programs over the last decade, we find the following patterns: i) Event-Driven and especially Relative Value strategies outperformed L/S Equity and Macro/CTA strategies during QE1, QE2 and QE3; ii) within Event-Driven, Special Situation strategies outperformed Merger Arbitrage on the back of their higher equity market beta; and iii) CTAs lagged overall and underperformed Global Macro strategies. If history is any guide, investors should consider these patterns when making allocation decisions. But we recommend proceeding with caution. There were only a limited number of QE events over the past decade and they took place during specific periods: in the aftermath of the Global Financial Crisis for QE1 and during the eurozone sovereign crisis for QE2. Thus, other factors influencing fund performance during those periods might not play a role in future scenarios. 

With these considerations in mind, our views on hedge fund strategies are to a large extent already geared towards the afore-mentioned patterns. We have long since maintained a preference for Event-Driven and Fixed Income strategies vs. Global Macro, CTA and L/S Equity. Also, our Overweight stance on L/S Credit should prove advantageous during future periods of monetary easing. Finally, our preference for Merger Arbitrage (Overweight) vs Special Situations (Neutral) and our preference for Market Neutral L/S (Overweight) vs. L/S Equity Directional (Underweight) does not reflect performance during asset purchase programs. But we believe it would be premature to embrace high beta strategies such as Special Situations and Directional L/S Equity. In our view, political risks such as Brexit and trade wars have the potential to disrupt the momentum in risk assets for the time being.