Hedge Funds Protect Portfolios Amid Market Volatility

Investing.com — Hedge funds have demonstrated their value in protecting portfolios during significant market volatility, as witnessed in August 2024.

UBS analysts noted that hedge funds, particularly those employing non-directional strategies, capitalized on market disruptions while safeguarding against losses in stocks and bonds.

With persistent market uncertainty, hedge funds are increasingly crucial for managing risks, enhancing returns, and addressing unpredictable economic conditions.

Contrary to expectations for a quiet summer, August 2024 saw considerable market turbulence. A mix of thin liquidity, weak U.S. economic data, and geopolitical concerns resulted in heightened volatility.

The volatility index spiked, and global equities faced sharp sell-offs, with the U.S. 60/40 portfolio dropping by 3.1% within three days, according to UBS analysts. Japan’s Nikkei 225 also suffered a remarkable 20% decline, emphasizing the delicacy of global markets.

“However, early August induced market jitters against a backdrop of thin liquidity due to weak U.S. jobs and manufacturing data, raising fears of a “hard landing,” the analysts stated.

The unwinding of leveraged positions, primarily in Japanese markets, worsened the situation, leading to substantial sell-offs across asset classes.

While traditional long-only portfolios struggled due to heightened correlations between equities and bonds, hedge funds thrived, providing uncorrelated returns and seizing opportunities presented by volatility.

UBS highlighted that hedge funds with lower market exposure, such as equity market-neutral and alternative credit strategies, significantly outperformed during August’s market fluctuations.

Convertible arbitrage strategies, benefiting from long volatility profiles, achieved a gain of 1.1% in August by taking advantage of sharp reversals in market sentiment.

Likewise, fixed income relative value strategies and credit hedges contributed positively, with UBS noting that many managers capitalized on widened spreads before markets stabilized.

Hedge funds not only provide downside protection but also excel in environments marked by market dislocations.

UBS analysts emphasized that during periods of volatility, prices often stray significantly from their intrinsic values, granting hedge fund managers unique alpha opportunities.

By adopting contrarian positions—buying undervalued assets or shorting overvalued securities—hedge funds can benefit as prices revert to their natural averages once markets stabilize.

UBS pointed to the success of discretionary macro strategies that navigated August’s turbulence by leveraging movements in global currency and bond markets.

One of the notable advantages hedge funds offer is their ability to yield uncorrelated returns during chaotic markets.

As correlations between asset classes surge during periods of stress, portfolios consisting of traditional assets like stocks and bonds are more susceptible to simultaneous declines.

Hedge funds, however, exploit market inefficiencies and take advantage of price dislocations, rather than merely following broader market trends.

According to UBS, strategies such as global macro, equity market-neutral, and multi-strategy funds have proven especially effective in delivering uncorrelated returns, aiding in smoothing portfolio performance and reducing risk.

These strategies enable investors to maintain exposure to high-risk markets while mitigating the impact of sharp downturns.

UBS analysts predict ongoing volatility in the months ahead as central banks modify monetary policies and geopolitical risks remain high. While inflation concerns have subsided, economic data continues to fluctuate, and the trajectory of future Federal Reserve rate cuts remains uncertain.

Simultaneously, the impending U.S. presidential election is expected to introduce further political uncertainty, potentially resulting in market swings.

Given these conditions, UBS advises investors to integrate hedge fund strategies into their portfolios to prepare for future volatility.

Low net equity strategies, alternative credit, global macro, and multi-strategy funds are viewed as well-positioned to help investors manage risks and seize opportunities as markets change.

While hedge funds offer significant prospects, UBS also warns of the associated risks. Hedge funds are often illiquid and may entail long-term lock-up periods.

Additionally, their strategies can be intricate, and investors should be ready for possible losses, especially when leveraging is involved.

Therefore, UBS urges investors to approach hedge fund investments within the framework of a well-diversified portfolio and ensure they are comfortable with the risks involved.