K2 Advisors Fourth Quarter Hedge-Fund Strategy Outlook
Given elements of uncertainty tied to COVID-19, geopolitics and policy decisions to come in the United States and across the globe, our K2 Advisors team believes the current environment may favor nimble, shorter-term strategies. Brooks Ritchey and Robert Christian provide the team’s fourth quarter hedge-fund strategy outlook.
The opportunity set remains attractive with major elections, geopolitical negotiations and policy decisions likely to play an important role in absolute and relative market moves over the medium term.
Long/Short Equity Generalist
Dispersion and volatility created by COVID-19 disruptions and US election uncertainty should be advantageous to long/short equity managers who have the ability to capitalize on both improving and weakening trends.
Managers often target a change in credit rating as a catalyst to realize an investment thesis. While the high absolute number of changes this year is a positive in general, the spike in downgrades favors managers that can generate alpha on the short side in particular.
Macro Themes We Are Discussing
Might inflation expectations continue to rise given recent fiscal and monetary stimulus?
Recent comments from the US Federal Reserve (Fed) and other central banks refer to the potential for inflation targets to be shifted to an average level instead of being capped at a specific target. This implies that policymakers may allow inflation to overshoot past inflation levels for a period of time. This policy shift comes at a time when interest rates are down to historically low levels, money supply growth has been strong, and indications are that rates will remain lower for years. Additionally, governments are talking about increasing fiscal spending, progress is being made on a vaccine to stem the risk of a COVID-19 resurgence, and economies are trying to reopen.
These and other factors may lead to market participants to ratchet up expectations for future inflation. As a result, yield curves may steepen, the US dollar may weaken, non-US equities may outperform and sector dispersion may increase. Hedged strategies able to pivot to this new regime should see increased long versus short alpha-driven opportunities. Specifically, the discretionary macro, long/short equity generalist, and long/short credit managers may see improved return-to-risk characteristics.