The Investing Landscape in 2017: Fertile Ground for Alternatives?

Success for most alternative strategies depends largely on producing returns from alpha—sources beyond broad market movements. It’s been harder to do that in recent years, but that could change in 2017.

A number of factors worked against alternative returns last year, including a stricter regulatory environment and low interest rates. And after the US election, volatility faded and equity markets rose steadily, making exposure to broad market moves—or beta—a winning strategy.

We don’t think this state of affairs will last indefinitely, though. Here are some of the bigger trends we see taking shape that could drive results this year and beyond for alternative investments.

SHORT-SELLING POTENTIAL ON THE RISE

We saw increased dispersion last year among individual stocks, forcing investors to differentiate again between weak and strong investments. This should improve short-selling opportunities for equity hedge strategies.

In recent years, a flood of monetary stimulus from major central banks has ended up lifting all boats—even the least seaworthy ones. That has made uncovering long/short potential in global stock markets a challenge.

Today, central bank policies are diverging. The Federal Reserve has already started to raise interest rates, with more hikes likely in 2017. This environment could make things difficult for some companies, industries and asset classes. And while central banks in Japan and Europe are still easing aggressively, the effect of their policies on financial markets has been fading somewhat.

Periods of higher interest rates also mean managers can earn a higher yield on the cash balances that result from successful short sales, providing another potential return boost. Rising-rate periods have historically been profitable for equity long/short strategies and active managers in general.

DEAL ACTIVITY HEATS UP

Corporate merger activity was vigorous last year, making it a good year for event-driven strategies; we expect more of the same in 2017. Deal spreads aren’t quite as wide as they were a year ago when the collapse or delay of several high-profile mergers drove spreads higher. But they’re still attractive, so this could be a good time to invest.

For starters, companies still have plenty of cash on their balance sheets. Activist investors have been pushing them to return cash to investors. But with interest rates still low, we think many companies can put it to better use by growing revenue and earnings through mergers and acquisitions.

Another potential positive: deregulation. Increased regulatory scrutiny of deals has slowed activity in recent years and affected the outcome of many event-driven strategies. The Republican sweep in the US presidential and congressional elections last year, however, could put deregulation back on the table. And talk in the Trump administration of a possible repatriation tax holiday for corporations with money parked overseas would bring more corporate cash into the US. There should be a lot of opportunities for event-driven and special-situation investing.