Evening Brief – 09.27.23

One-third of investors intend to expand their overall exposure to credit hedge funds as data suggests these strategies generate similar levels of alpha but significantly lower volatility than typical long/short managers, according to Barclays research.

Credit Matters: A Deep Dive into the Credit Hedge Fund Landscape analyzed where allocators intend to spend capital in the credit hedge fund space between now and the end of the year.

Long/short and distressed funds are attracting the most attention, with private banks significantly more eager to deploy capital into each of these strategies than pension funds and insurance companies.

Approximately 1/3rd of investors plan to increase their exposure to credit long/short hedge funds for the remainder of 2023. In contrast, only 3% intend to reduce their exposure.

Likewise, 29% aim to increase their investments in distressed credit strategies, while only 3% intend to decrease their investments. Meanwhile, 19% intend to increase their investments in credit multi-strategy hedge funds and 17% in structured credit.

However, when it comes to allocation plans, the study discovered a significant divide across investor types.

Half of all private banks intend to increase their investments in long/short credit funds, with 42% of fund of funds and 28% of family offices eager to deploy cash. However, interest declined to 14% among pension funds, insurance companies, and sovereign wealth funds, and 10% among foundations and endowments. The levels of interest in distressed strategies were basically comparable.

The findings come as hedge fund investors’ allocation plans are being scrutinized in the face of rising interest rates, an uncertain economic climate, and mediocre returns this year.

While annualized returns for credit hedge funds have trailed those for discretionary equity strategies in recent years, alpha creation has been nearly comparable, at 2.5% versus 2.6%, according to the study.

However, during the last decade, the average volatility of credit hedge funds was 7.3%, far lower than the 13.5% for discretionary equity funds. As a result, despite equity managers’ larger nominal returns, the resulting Sharpe ratios are basically identical, at 0.7 for credit hedge funds and 0.8 for equity hedge funds.

“While the amount of alpha generated annually was very similar over the long run, we found that the correlation of credit and equity alpha was only around 60%, which suggests that not only are there some common factors that affect alpha generation across the strategies, but also that there is sufficient diversification across the two strategies for investors to have exposure to both,” the authors wrote.

Barclays surveyed 230 investors in addition to approximately 30 credit hedge fund managers. Approximately 40% were private investors, including single and multi-family offices and private banks, with the remaining 30% being institutional investors.