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For years, the hedge fund climate was tough. Volatility was low. The price of everything was going up. It wasn’t that hard to make money. In that kind of environment, why think outside the box?
But as central banks continue their aggressive campaign of interest rate hikes aimed at bringing down inflation to send markets on a rollercoaster ride, alternative strategies are taking on a different look.
“Certain hedge fund strategies can perform well in volatile, sideways-moving markets, an environment we expect to persist into next year,” Mark Haefele, chief investment officer at UBS Global Wealth Management, told clients on Tuesday.
On the heels of a summer rally, the markets have started to move again. Concerns have grown ahead of the Federal Reserve’s meeting on Tuesday and Wednesday, where the only debate will be how much to raise rates.
The S&P 500 just recorded its worst week since June. Government bonds are also experiencing strong selling. The benchmark 10-year U.S. Treasury yield, which moves against prices, hit a more than decade high on Monday.
No matter what the Fed announces tomorrow, uncertainty is likely to persist, with the central bank planning to continue making decisions on a meeting-by-meeting basis.
“Volatility will be a key theme in the back half of the year, largely because central banks remain data-driven,” Laura Cooper, chief macro investment strategist at BlackRock, told me.
That’s fueling interest in hedge funds, through which professional investors try to beat the market by deploying unconventional approaches.
These funds struggled in the wake of the global financial crisis. Low interest rates and a period of relative calm in the markets limited the opportunity for the contrarians. Now, they have an opening again, and some are finding success.
Hedge fund performance improved in August, even as the stock market fell, according to the latest reading of the HFRI 500 Fund Weighted Composite Index, which tracks the industry’s leading funds.
Not all fund types are created equal. Macro funds, which want to take advantage of political and economic volatility, have been a highlight. That category is up 14.8% for the whole year, while the S&P 500 is down 17% through August.
Investors trying to take advantage of the turmoil in commodity markets have done particularly well, according to Robert Sears, chief investment officer at Capital Generation Partners, which invests in hedge funds for wealthy families.
There are also opportunities to pick up stocks, and some companies are better positioned to weather high inflation and economic downturns. In recent days, warnings from companies including Ford ( F ) and FedEx ( FDX ) have fueled concerns that a wave of earnings declines could follow.
“Until the earnings come down and the Federal Reserve starts to ease policy, you’re in for an environment where hedge funds should do pretty well,” Sears told me.
Not everyone wants to take more risk. Nuno Matos, chief executive of wealth and personal banking at HSBC, has noticed a major shift in his clients.
Global investors are “not as active as they used to be,” with many looking to buy “more protection for their portfolios,” Matos said in an interview with CNN Business colleague Michelle Toh on Monday.
“We see clients sitting a little on the sidelines,” Matos said, adding that many turned to bonds as they sought “stability.”
Matos shared how Europe’s largest bank advises its clients, which include high net worth and retail investors.
For starters, diversification is now not a luxury, but a “must,” the executive said.
That’s not all: He also suggested investors look at “value” stocks over “growth” stocks, essentially prioritizing large companies with stable market share and healthy payouts to shareholders over other growing businesses.
Even though many people are selling assets, “you want to stay invested,” Matos said, noting the harmful effects of holding onto cash during a time of high inflation.
The banker also said his team was bullish on the strength of the US dollar, partly because he believed the US economy was “weathering the storm better than, for example, the European economy”. The US dollar has risen to a 20-year high, while many other currencies have fallen.
How long will it last? Matos predicts that the current holding pattern among investors will extend into the middle of next year as markets gain a better understanding of how interest rates will stabilize and have “some breathing room.”
Sweden kicked off a crucial week of central bank decisions with a surprisingly large interest rate hike, setting the tone for imminent announcements from the Federal Reserve, Bank of England, Bank of Japan, Swiss National Bank and Norway’s Norges Bank.
Just this: The Riksbank raised rates by a full percentage point to 1.75% on Tuesday as part of a bid to slow price rises. Inflation in the country rose to 9% in August.
“Inflation is too high. The purchasing power of households is weakening and it is making it difficult for companies and households to plan their finances”, the central bank said in a statement. “Monetary policy must now be tightened further to bring inflation back to target.”
Why it matters: The European Central Bank, the Riksbank’s counterpart, raised rates by three quarters of a percentage point earlier this month. Since then, however, the concern that inflation remains more stubborn has been working on financial markets.
Investors see an 80% chance the Fed will raise interest rates by three quarters of a percentage point on Wednesday. But after data last week showed inflation rose more than expected in August, they are leaving room for a full point move.
U.S. housing starts and building permits for August post at 8:30 a.m. ET. Stitch Fix ( SFIX ) reports results after US markets close.
Coming Tomorrow: It’s about the Federal Reserve’s latest policy decision.