Investors clearly can’t make up their minds about where stocks are heading in 2016.
The good news is that there’s a hedge fund strategy for that, and it’s set to be a very popular approach.
Fundamental equity market neutral funds, or hedge funds that take an offsetting number of longs and shorts with the goal of generating alpha no matter the market direction, are in fashion, according to Deutsche Bank.
The bank‘s global prime finance group surveyed 504 hedge fund allocators (fund of funds, pension funds, family offices, endowments, foundations, etc.) who collectively manage and/or advise on $42 trillion in total assets and $2.1 trillion of hedge fund assets.
The hedge fund industry is made up of many different types of strategies — long/short equity, activist, event-driven, distressed credit, global macro, the list goes on. Allocators have to decide which strategies are poised to perform.
Deutsche Bank found that the “most in-demand” strategy was the equity market neutral strategy.
About 32% of the respondents said they were increasing their exposure to fundamental equity market neutral managers, up from 17% in 2015. A further 18% of the allocators were increasing their exposure to systematic equity market neutral funds, up from 11% in 2015.
Citadel, the giant hedge fund led by Ken Griffin, employs the strategy. AQR launched an equity market neutral fund in 2014, while the Chicago-based Alyeska Investment Group is also in this space.
Investors had been underweight the strategy, according to Marlin Naidoo, head of capital introduction and hedge fund consulting in the Americas for Deutsche Bank.
“2015 was a year where we saw some good performance coming out of equity market neutral and the quantitative equity market neutral space as well,” Naidoo told Business Insider.
“It’s not unusual to see strategies that performed well become the more favored strategy in the next year,” he said.
CNBC/ Heidi GutmanToward the tail end of 2015, investors had the view that equity markets might be volatile and that there would be opportunities on the short side. Investors are expecting more volatility in 2016, and market neutral funds are one way to manage that.
“Typically, market neutral managers tend to have more diversified portfolios with more names,” Naidoo said. “Investors are utilizing that diversification to manage a volatile environment.”
These sorts of hedge funds take long positions in stocks they think will outperform the market and short positions in stocks they think will underperform, aiming to hedge out broader market moves.
In finance lingo, they aim for a beta to equity markets of zero. That’s appealing to investors when the market is volatile.
All that said, there aren’t many true equity market neutral funds out there. There may be only a few dozen true fundamental equity market neutral funds with $1 billion-plus in assets under management.
Despite hedge funds as a group having a terrible year in 2015 and a brutal start to 2016, money continues to flow into the industry.
According to the results, most of the respondents expect hedge funds to outperform equity markets in 2016. What’s more, 41% of them plan to increase their hedge fund allocations over the next 12 months, up from 36% who increased in 2015.