|| Tim Ng
Due to the market uncertainties that abound in Europe and
Asia, along with the political impasse seen in the U.S. and
social unrest in the Middle East, the global economic outlook
On the positive side, global monetary conditions will likely
ease in order to foster economic growth. The European Central
Bank, Bank of England, and various emerging market central
banks are likely to make use of their printing presses. The
Eurozone is expected to be in recession going into 2012, with
moderate growth expected in the years ahead. Business and
consumer confidence is weak in Europe as expected due to the
financial market stresses. As such, capital formation remains
weak as well as private consumption.
U.S. growth should come in around 2.5% as real consumer
spending has increased. There should be continued increases in
manufacturing output and improvement in employment as witnessed
by the recent decline in jobless claims.
When looking at China and emerging Asian countries, we do not
foresee a hard landing, but a soft one with GDP growth in China
slowing from 9.1% in 2011 to 8.1% in 2012. The continued growth
in Chinese domestic consumption and easing monetary and fiscal
policies should help GDP growth remain on a positive
trajectory. Emerging Asian country growth remains positive in
India, Malaysia, Thailand, and Philippines, bolstered by
resilient domestic demand.
Despite those positive signs, hedge fund returns in 2012 will
be reflective of a mixed market environment. Risk aversion
still characterized markets early in the year, but we expect a
divergence of global growth later in 2012. Strong growth in
emerging and developing markets will combine with recession in
Europe and slow growth in the U.S. and Japan. As such, we
believe asset valuations in 2012 may be driven more by
fundamental than macro factors, but we expect market volatility
to remain higher than normal with the potential for downside
drafts. Another theme is the investor search for yield as short
rates continue to be negative in real terms.
So, which are the hedge fund strategies to pick? First, we
like market neutral long/short equity investing as we expect
greater divergence and lower correlation of stock prices in
2012. And for stocks, we also like managers that invest in
emerging markets. They performed poorly due to capital flight
in 2011, leaving such the markets with low valuations. Combined
with monetary policies to foster growth, emerging market stock
prices should recover. Emerging market debt is also attractive
based on higher yields, stronger credit worthiness and the
values of emerging market currencies versus those of developed
For developed markets, investing in high-yield corporate
bonds is a good alternative as sovereign debt is priced to
perfection, and money market alternatives are providing
negative real yields. Default rates continue to remain low
and corporate balance sheets are strong and still retain a
great deal of cash on hand.
After a difficult year, global macro managers should recover
as themes in currencies, commodities (energy and metals), and
interest rates should have greater visibility in 2012,
providing good trading opportunities.
We also like options-based strategies. They can both enhance
yield via the sale of covered call options or the combined use
of short call and long put spreads to hedge downside equity
market risk while offsetting a portion of the downside
protection cost. In addition, we favor strategies that are long
volatility as it will spike dramatically in a market downturn.
The firm is also in favor of strategies that can take advantage
of widening sovereign debt and credit spreads, either in the
form of CDS or straight short debt positions.
And which hedge funds strategies should be avoided?
Strategies that will be out of favor include long-biased
long/short equity, as we foresee equities markets will be
subject to bouts of volatility and thus downside risk. Merger
arbitrage is also risky as deal spreads are subject to not only
idiosyncratic but also market risk, and we believe the present
overhang of global economic and political uncertainty will
cause so-called CEO paralysis and the number of deals that will
transpire will leave a lot to be desired. Also, distressed debt
could be confronted with tail winds as any de-risking phase
will cause bouts of illiquidity and cause spreads to widen.
Clearbrook has been working with its clients to incorporate
hedge funds in order to decrease the amount of equity beta or
volatility (or both) in their portfolios. In addition, we are
looking at hedge funds to provide yield alternatives to
traditional fixed income investments due to their low to
negative real yields, as well as the eventual duration and
interest rate risk that will come.
Timothy Ng is a managing director at investment
consultant Clearbrook Investment Consulting
Investor Outlook: Huge disparities, no shift to small