12 months ago • 2 mins
It was one year ago this month that the Federal Reserve began raising interest rates, in hopes of tamping down the country’s worryingly high inflation. And rates are now a lot higher than they were (roughly 4.5%, compared to roughly zero). Now, higher rates can have huge effects on different asset classes. And that can create major opportunities for investors such as hedge funds.
This chart tracks the monthly annualized returns across hedge funds, equity L/S (long/short) funds, and equity markets (MSCI World total return), dating back to 1990, based on different interest rates (gray blocks). The pattern that quickly emerges is that rates above 4% lead to higher hedge fund and equity L/S returns, but especially when they move above 6%. In times like that, they both have outperformed the MSCI World Index.
There are good reasons for this. See, with higher interest rates, any cash on hand (short sale proceeds or leftover money from using derivative strategies or leverage) will earn a higher yield. Plus, higher rates tend to cause more differentiation between asset prices (we call this “wider dispersion”), which drives correlations lower – and that means assets don’t just all move in tandem with one another.
As you can see from the chart, as rates rise, equity dispersion increases and equity correlation decreases. This creates fertile ground for hedge funds to generate superior returns using their sophisticated strategies and skills to find the things that might go one way, even when other things are going the other way. A simple example could be that higher rates may reduce one company’s ability to pay down their debt, if, say, they’re highly levered, they might have a far less significant impact on a company with a stronger cash-flow profile.
If you’ve ever thought about entrusting some of your money with a hedge fund, now might not be a bad time. You can find a list of them here. Or, you could consider buying the Goldman Sachs Hedge Industry VIP ETF (ticker: GVIP; expense ratio: 0.45%), which tracks the 50 top stocks, as ranked by hedge funds.
Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.