Hedge Fund Outlook For 2023: What To Expect As Managers Face Increased Complexity

As investors and fund managers prepare to flip their calendars from 2022 to 2023, they have their work cut out for them.

Hedge Fund Outlook For 2023: What To Expect As Managers Face Increased Complexity

As investors and fund managers prepare to flip their calendars from 2022 to 2023, they have their work cut out for them. In 2022, commodities and macro funds were the big outperformers, and for good reason. This past year brought the first major war in Europe in 75 years and wrapped up the first pandemic in a century. Meanwhile, spearheaded by the Federal Reserve, the world's central banks have been trying to tame inflation — with relatively little impact. BlackRock BLK believes central banks are "deliberately causing recession by overtightening policy to tame inflation," a view that many asset managers share. WASHINGTON, DC - DECEMBER 14: Federal Reserve Board Chairman Jerome Powell speaks during a news ... [+] conference after a Federal Open Market Committee meeting on December 14, 2022 in Washington, DC. The Federal Reserve announced that it will raise interest rates by a 0.5 percentage point to 4.5. (Photo by Alex Wong/Getty Images)Getty Images

So what does all this mean for 2023? Many of 2022's macro conditions will remain in place in the new year, although every year brings its own set of challenges. In a recent interview with ValueWalk, Jay Peller of the Citco group of companies said he continues to see a bright future for alternative investments in 2023. "As investors adapt to the new market environment and seek out alternative investments to provide them with a diversified source of potential returns, we expect end investors to continue to turn to hedge, private equity, private credit and real assets funds in increasing numbers in 2023," he said.

For most of 2022, macro funds were among the big outperformers on the back of rising interest rates, soaring commodity prices, and currency shifts as the dollar strengthened against other currencies. However, Citco data reveals that commodities funds actually outperformed global macro funds through the end of November, generating a weighted average return of 19.49% and a median return of 12.99%. Global macro funds were close behind with a weighted average return of 16.47% and a median return of 10.75%. Across all strategies, the funds administered by Citco generated a total weighted average return of -6.49% and a median return of -3.5% for the first 11 months of 2022. However, going into 2023, one thing most investors are concerned about is whether there will be a recession. The Fed has been clear about its intention to keep raising interest rates until inflation is under control. As a result, the debate about whether the central bank will be able to engineer a so-called "soft landing" has been heated. All these dynamics suggest macro fund managers could find some situations similar to those they capitalized on in 2022.

Investor flows

Of course, it's anyone's guess whether 2023 will bring net inflows or outflows, either for macro funds or for the industry as a whole. However, it could take a few months before any trends can be seen clearly.

As of November, Citco observed plans for $9.5 billion in outflows for 2023, although the exact timing of those flows will remain unclear until the last day of the year. Overall though, Peller expects 2023's capital flows to be somewhat similar to 2022's flows.

More private credit, hybrid and multi-strategy fund offerings

He also expects to see an increase in private credit strategies as fund managers take advantage of the gap left by banks that are no longer able to lend like they used to.

"A lot of private credit strategies have seen huge growth in the last two years," Peller noted. "I think that growth continues next year, and I think as far as regulation and costs, all the complexities will continue."

In 2022, he has also been seeing more and more pure ESG (environmental, social and governance) funds. Looking into 2023, he expects even more ESG funds to be established.

Peller also expects an increase in multi-strategy funds, which became increasingly popular in 2022. Citco recorded net inflows of $6 billion into the multi-strategy funds it administers during the first 11 months of the year — despite their weighted average loss of 7.12% and median loss of 2.53% over that timeframe.

Hybrid funds also increased in popularity in 2022, based on the net inflows of $31 billion for the first 11 months of the year. Fund managers have responded to that interest by expanding their funds and offering new hybrid strategies. For example, a long/ short equity fund manager might add a private equity vehicle to help smooth out their liquidity and overall returns.

Coping with increased complexity

Of course, as hedge funds try to generate alpha in different places, they're becoming more and more complex. That increased complexity is leading to a lot more data being generated and analyzed as fund managers seek alpha. As a result, hedge funds need technology capable of more complex data analytics. Peller believes fund managers who don't invest in such technology could get left behind.

"As managers grow in complexity to meet investor requirements, we predict that the demand for outsourcing will continue to soar as the need for data and digitized processes increases," he added.

Peller expects 2023 to continue the transformation and hedge fund investments into new and more advanced technology.

Growing regulations

Another part of that increasing complexity is the growing number of regulations fund managers have to deal with every year. In 2022, Europe imposed sweeping new regulations that required investors to start collecting data on the companies they invest in. Those requirements will become even harder to deal with in 2023.

"Alongside the challenging market environment, managers will also need to adapt to evolving regulatory requirements," Jay notes. "With the likes of the Sustainable Finance Disclosure Regulation's (SFDR) level two requirement taking effect in January 2023… there will be an even greater demand from investors on transparency and reporting."