The long and the short of unstoppable trends

SUMMARY

Certain specialist hedge funds strategies seek to exploit performance differences between the winners and losers of unstoppable trends.


Powerful long-term forces are revolutionizing the ways we live and do business globally. These include digitization, increasing human longevity and the continued shift of economic power towards Asia. We call these forces “unstoppable trends,” which have the potential to  prove themselves as major, multi-year themes that may transform the world around us. We believe these unstoppable trends can endure throughout economic cycles, offering resilient growth potential to investors who harness them in portfolios.

For qualified investors, long-short hedge fund strategies may offer a relevant way to gain exposure to unstoppable trends. Such strategies seek to benefit from the difference in performance between related equities. The idea is to add exposure to the potential winners of a certain unstoppable trend, while simultaneously short selling potential losers of the same trend. If the potential winners indeed outperform the potential losers, the long-short strategy generates positive returns. Importantly, the strategy may deliver positive returns even when the broad equity market is declining, provided that the long positions decline by less than the short positions.

Of course, the outcome of this strategy depends significantly on the skill of the long-short hedge fund manager. Specifically, the manager needs to be able to select the appropriate companies in which to establish long and short positions. If the manager’s assessment of likely winners and losers of an unstoppable trend is incorrect or premature, the strategy could see short positions outperform the long positions, leading to outright losses.

Over the last ten years, long-short strategies overall have struggled to keep pace with the bull market in equities. Select specialists, however, have managed to achieve stronger performance. For example, long-short strategies focusing on the technology and healthcare sectors have produced both higher absolute and risk-adjusted returns. One reason for this is the wide range in returns between the strongest and weakest equities in these sectors. Such dispersion creates more potential opportunities for managers to apply their selection skills.

Figure 1 shows performance statistics of the HFRI Equity (Total) Index, the HFRI EH: Sector – Technology/Healthcare Index, and the MSCI World Index for the ten years ending June 2023.

 

Figure 1
June 2013 - June 2023 HFRI Equity Hedge (Total) Index HFRI EH: Sector – Technology / Healthcare Index MSCI World TR Net Index (USD)
Annualized Return 5.4% 8.6% 9.2%
Annualized Volatility 8.5% 9.1% 14.7%
Sharpe Ratio 0.53 0.84 0.56

Source: HFRI and Bloomberg. The HFRI Equity Hedge (Total) Index tracks strategies that invest in both long and short positions primarily in primarily equity and equity derivative securities. The HFRI EH: Sector - Technology/Healthcare Index tracks strategies that specialize in technology, biotechnology and as related to production of pharmaceuticals and healthcare industry. Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance. Past performance is no guarantee of future results. Real results may vary

We believe that such opportunities for specialists to outperform will likely persist over the coming years. Here are some of the areas that we believe are ripe for long/short managers to apply their skills.

Digitization

Citi Global Wealth Investments has highlighted the accelerating adoption of technology across almost every industry and business, creating a “new normal” of an increasingly data-enabled, decentralized and flexible global economy. Trends including artificial intelligence (”AI”), 5G, fintech, cloud applications and cybersecurity are accelerating and revolutionizing the world around us as we become ever more connected and reliant on innovation. Technology-focused hedge funds may seek to focus long investments in the aforementioned long-term themes, while shorting companies that may face near-term cyclical headwinds, lack competitive advantages, and / or are being disrupted by new competitors. Managers that have strong track records of identifying winners and losers in the technology ecosystem have the potential to generate value.

Increasing Longevity

More people are living longer than ever before, highlighting the unstoppable trend of increased human longevity that is driving healthcare spend and innovation. Ample opportunity exists for companies that address unmet clinical needs and strive to improve the quality and cost of the existing standard of care. Faster-growing health care segments like biotech and life sciences should be relatively uncorrelated to the economic cycle. Health care equities are poised to benefit from increased utilization trends, clinical developments, and a supportive M&A backdrop. Companies that have achieved proof of concept and are concentrating on commercializing and scaling their products & services are potential long investments, while drug development programs with a high degree of failure often lead to short ideas.

G2 – The Rise of Asia

The continued shift in economic power toward Asia remains an area of focus with potential investment opportunities in China for both returns and diversification. The confluence of global market conditions including higher rates, inflation, and recessionary fears as well as specific concerns on the Chinese economy and regulatory regime has caused the China A-share market to trade at relatively low forward earnings multiples, providing a potentially attractive entry point for investment. The China A-share market is conducive to active investing given its inherent  inefficiency due to low institutional ownership and high trading volumes dominated by local retail investors. Such dispersion creates potential opportunity and enables specialized active managers to leverage their stock selection skills that may generate outperformance.  

OUTLOOK

Alternative investments Outlook 2023

The past few quarters have been marked by uncertainty, volatility and public market paralysis which has stretched investor confidence as portfolios got whipsawed through the news headlines and Federal Reserve tightening cycle.

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