Interest rate reversal dampens regulated hedge funds – highest outflows since 2008 despite strong performance

Hedge fund strategies in the UCITS format were severely affected by the market distortions after the interest rate reversal in 2023. Net outflows from this asset class reached €17.65 billion in 2022 and €35.1 billion in 2023. To put this into perspective: In July 2022, after more than six years, the ECB raised interest rates from 0% to 0.5%. Since September 2023, the ECB key interest rate has remained at 4.5% after nine further steps. Initially, the prices of safe Euro government bonds fell by almost 20% as a result of the massive rise in interest rates. However, with the return of interest rates, investors quickly and decisively turned to the interest rate market. This led to a massive reallocation, which also left its mark on the investment strategies analysed. In the first quarter of 2023, the Deutsche Bundesbank reported “historically high shifts” to fixed-interest investments, a trend that accelerated later in the year.

 

In keeping with this new interest rate environment, nearly 40% of gross inflows into liquid alternatives were attributable to the only two fixed-income strategies in the segment: Alternative Credit Focus and Absolute Return Bond. However, the key to a high return in 2023 was in the equity market, with Liquid Alternatives clearly lagging behind with an average performance of 5.28%. Focusing purely on performance, however, does not take into account their stabilising contribution to the overall portfolio. This is evidenced by the medium and long-term perspective. In the disastrous investment year of 2022, when equities and bonds fell simultaneously, Liquid Alternatives stabilised their investors’ portfolio returns, while bonds viewed over three and five years are still chasing their losses today. The same applies to volatility and maximum drawdowns. Here too, Liquid Alternatives show their strengths: Over five years, their average maximum drawdown was 17.9%, compared with 25.3% for the Euro Stoxx 50 (on a monthly basis).

Glossar

Absolute Return	Funds characterised by a highly regulated market environment and an absolute return target. They aim to add value in every market environment. They are usually measured against a risk-free or cash benchmark instead of a traditional long-only benchmark.
Absolute Return Bond	Funds that pursue positive return targets in all market situations and primarily invest in debt securities. Products with the words “Absolute Return” added to their name or investment objective may be included in this category. In this case, the benchmark is usually a risk-free or cash benchmark instead of a traditional long-only market index.
Alternative Credit Focus	Funds that invest in structured credit products and whose investment process is characterised by either fundamental credit analysis, quantitative approaches or (market) opportunities.
Alternative Currency Strategies	Funds that invest in global currencies to exploit arbitrage opportunities (carry, momentum, fundamental opportunities). They use short-dated money market instruments and derivatives to achieve their objectives. Funds that invest the majority of their assets in cryptocurrencies also fall into this category.

Alternative Dedicated   Short Bias	Funds that maintain a net short profile on the market on an ongoing basis. This category also includes funds that exclusively take short positions.
Alternative Equity Market Neutral	Funds seeking to generate consistent returns regardless of market phases. The portfolio is also managed with a net market exposure of zero.
Alternative Event Driven	Funds that aim to exploit price inefficiencies caused by a business transaction (e.g. insolvency, acquisition, spinoff, etc.) in accordance with their sales prospectus. Event-driven funds can invest in a variety of instruments with different risk structures (e.g. equities, credit instruments, derivatives).
Alternative Global Macro	Funds that make global investment decisions based on economic theories. These strategies typically base their decisions on interest rate expectations, expectations concerning political developments, and other macroeconomic and systemic factors. Global macro funds typically use a wide range of instruments and investment universes to implement their investment ideas.
Alternative Long/Short Equity	This strategy uses both long and short positions in equities, equity options and equity index options. The portfolio manager can decide whether the net position of their fund is positive or negative depending on their market view.
Alternative Managed Futures	Funds that primarily invest in a portfolio of futures contracts and aim to generate positive returns that are independent from the market in any situation with limited volatility. Their investment approaches consist of proprietary trading strategies that can include both long and short positions.
Alternative Multi Strategy	Funds that aim to generate an overall return by managing several different hedging strategies. These funds typically follow a quantitative approach and seek to identify opportunities where there are changes to the long-term risk-adjusted relationship between two securities.
Alternative Relative Value	They use option and arbitrage strategies on highly correlated pairs of securities to exploit price differentials. In such cases, the funds sell the more expensive security (short position) while taking a long position in the relatively cheap security.
Alternative Equity Leveraged	Funds designed to generate more than 100% of the daily performance of a benchmark index. They use a customised combination of futures contracts, derivatives and leveraged products to achieve this.

About the Study 

Since 2008, Lupus alpha has been evaluating the universe of absolute return and alternative funds on the basis of data from LSEG Lipper (formerly Refinitiv). The Study covers UCITS-compliant funds with an active management approach that are authorised for distribution in Germany. The Study focuses on market size, development and composition, performance in the investment segment and individual strategies, as well as key risk figures. It evaluates the three levels of aggregation – the overall universe, strategies within the universe, and funds within the strategies – and distinguishes between 14 strategies. The Alt. Long/short equity strategy, for example, includes 102 funds. 

About Lupus alpha

As an independent, owner-operated asset management company, Lupus alpha has been synonymous with innovative, specialised investment solutions for over 20 years. As one of Germany’s European small and mid-cap pioneers, Lupus alpha is one of the leading providers of volatility strategies as well as collateralised loan obligations (CLOs). The specialist product range is rounded off by global convertible strategies and risk overlay solutions for institutional portfolios. The Company manages a volume of more than €14.0 billion for institutional and wholesale investors. For further information, visit www.lupusalpha.de. 

For further information visit www.lupusalpha.de.

 

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