Hedge funds are well positioned to navigate market fluctuations, says UBS By Investing.com

Investing.com – Hedge funds have shown value in protecting portfolios during periods of significant market volatility, as seen in August 2024.

UBS analysts said in a note that hedge funds, particularly those using non-directional strategies, took advantage of market disruptions while protecting against losses in stocks and bonds.

With continued market uncertainty, hedge funds are becoming increasingly important to manage risk, increase returns and manage unpredictable economic conditions.

Contrary to expectations of a quiet summer, August 2024 generated significant market turbulence. A combination of tight liquidity, weak US economic data and geopolitical concerns led to heightened volatility.

The volatility index rose and global stocks saw a steep sell-off, with the US 60/40 portfolio falling 3.1% in just three days, according to UBS analysts.

225 also saw a dramatic 20% drop, highlighting the fragility of global markets.

“However, early August brought jitters to the market against a backdrop of poor liquidity due to weak US jobs and manufacturing data, raising concerns of a ‘hard landing,'” analysts said.

The unfreezing of leveraged positions, particularly in Japanese markets, exacerbated the situation and led to significant selling across asset classes.

While traditional long-only portfolios have suffered from increased correlations between stocks and bonds, hedge funds have excelled by providing uncorrelated returns and taking advantage of opportunities presented by volatility.

UBS reports that hedge funds with less market exposure, including those using equity market-neutral and alternative credit strategies, significantly outperformed during August’s market swings.

Convertible arbitrage strategies, which benefit from long volatility profiles, gained 1.1% in August, capitalizing on sudden reversals in market sentiment.

Similarly, relative value fixed income strategies and credit hedges contributed positively, with UBS noting that many managers were able to monetize gains from widening spreads before markets rebounded.

Hedge funds not only provide protection against downside, they also thrive in environments characterized by market dislocations.

UBS analysts point out that during periods of volatility, prices often deviate significantly from their intrinsic values, providing hedge fund managers with unique alpha opportunities.

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

UBS highlights the success of macro discretionary strategies, which have weathered August’s turbulence by capitalizing on movements in global bond and currency markets.

One of the key advantages that hedge funds offer is their ability to provide uncorrelated returns during periods of market volatility.

As correlations between asset classes increase during periods of stress, portfolios comprising traditional assets such as stocks and bonds become more vulnerable to simultaneous declines.

Hedge funds, however, are designed to exploit market inefficiencies and take advantage of price dislocations, rather than simply riding broader market movements.

According to UBS, strategies such as global macro, equity market-neutral funds and multi-strategy funds have been particularly effective in delivering uncorrelated returns, helping to smooth portfolio performance and reduce overall risk. These strategies allow investors to maintain exposure to high-risk markets while mitigating the impact of sudden sales.

UBS analysts predict continued volatility in the coming months as central banks adjust monetary policies and geopolitical risks remain elevated. While inflation concerns have eased, economic data continues to fluctuate and the path of future Federal Reserve rate cuts remains uncertain.

Meanwhile, the looming US presidential election is expected to bring even more political uncertainty, which could lead to market swings.

With these factors in mind, UBS recommends that investors incorporate hedge fund strategies into their portfolios to prepare for future volatility.

Low-equity strategies, alternative credit, macro-global funds and multi-strategies are considered well-positioned to help investors manage risk and capture opportunities as markets evolve.

While hedge funds present significant opportunities, UBS also points out the risks associated with these investments. Hedge funds are often illiquid and may require long lock-up periods.

In addition, their strategies can be complex and investors should be prepared for potential losses, especially when using leverage.

As such, UBS urges investors to approach hedge fund investments in the context of a well-diversified portfolio and ensure they are comfortable with the associated risks.