Analyses
All About Alpha: Capturing Returns in Today's Market Environment
|
|
Alternatives
|
• |
août 23, 2024
|
All About Alpha: Capturing Returns in Today's Market Environment
|
août 23, 2024
|
All About Alpha: Capturing Returns in Today's Market Environment
All About Alpha: Capturing Returns in Today's Market Environment |
|
As we approach the final months of 2024, it’s easy to have a vague sense of déjà vu about financial markets. In some ways, 2024 looks eerily similar to 2023: equity indexes posted a strong first half of the year, driven by a handful of technology stocks, markets continue to reprice central bank policy expectations, which has driven ongoing volatility, while geopolitical tensions and other macroeconomic concerns remain.
Today’s environment stands apart from prior growth-led markets in a crucial way: it has been—and remains—a ripe environment for hedge fund alpha generation.
From Macro to Micro
AI and tech euphoria has seemingly taken hold of markets once again. Even after the volatility in late July and early August, which pressured many year-to-date high flying tech stocks, the market cap weighted S&P 500 index has outperformed the equal weighted S&P 500 by large margins year to date, through August 5. With more than 40% of the S&P 500 market cap concentrated in TMT sectors, it’s easy for these headlines, and headline-level returns, to mask the pronounced dispersion in other areas of the market.
In the macro-driven environment that persisted for much of 2022 and 2023, assets moved largely in response to inflation, interest rates and other macroeconomic factors. 2024 has increasingly seen an environment driven more by micro fundamentals. In fact, an internally maintained S&P 500 risk-on/risk-off model, which quantifies the degree of shared risk and market-wide co-movements, has declined this year, suggesting that macroeconomic factors are weighing less on equity markets. This has coincided with an uptick in stock-specific risk, suggesting that fundamentals are increasingly influencing stock prices. We believe that these dynamics are a direct result of the higher interest rate environment, which has resulted in increased opportunities for alpha production conducive to hedge fund strategies seeking to deliver skill-based returns to investors.
We wrote last year about the higher interest rate environment and its myriad impacts on hedge fund strategies. In addition to higher yields on unencumbered cash for derivatives-oriented strategies, plus the benefits of the short rebate in long/short equity strategies, higher rate environments have historically coincided with lower levels of correlation in the market, as elevated costs of capital have disparate impacts across sectors, industries and individual issuers.
These environments have led to outsized performance by long/short equity market-neutral hedge funds which are reliant on stock picking to generate their returns. In periods during which markets showed the highest cross-sector correlation, the average equity market-neutral fund monthly return was 0.18%. During periods when markets showed the lowest average pairwise correlation— here dispersion was apparent—the same funds generated an average monthly return of 1.08%.
Current Market Dynamics
While certain secular themes remain— notably the artificial intelligence boom—2024 has seen clear evidence of performance dispersion both across and within sectors, as fundamentals are increasingly driving asset prices. Interestingly, stock dispersion has increased since the equity market rally that began in late April. In many instances, during a clear ‘risk-on’ environment, we would expect to see dispersion fall, as stocks broadly move based on sentiment and less so on underlying fundamentals.
Dispersion Has Increased Despite the “Risk On” Environment
Examining the performance of several individual equities illuminates this point further. Prior to 2024, Tesla’s stock price remained on an upward trajectory, rallying even on weak earnings prints for much of 2023. In 2024, however, price has become much more aligned to earnings results despite outperformance of the consumer discretionary sector.
Elsewhere in the consumer sector, Dicks Sporting Goods’ rallying on strong earnings and Nike’s dropping on a weak print tell a similar story.
All About Alpha
This fundamentally driven environment has resulted in prolific hedge fund alpha generation over the past 12 months: on average, equity market-neutral hedge fund managers have generated alpha of 8.47%. However, this has not translated to improved alpha production by long-only equity managers, who have seen negative alpha of -3.60%, on average, over that same time period.
In our view, this dynamic provides evidence of two other reasons that hedge funds are uniquely well-positioned to deliver skill-based returns to investors: their ability to generate both long and short alpha, and hedge funds’ unconstrained approach versus traditional benchmarks.
1. HEDGE FUND ABILITY TO GENERATE BOTH LONG AND SHORT ALPHA
Long only active managers are primarily able to express their fundamental views through relative under- or overweighting of securities. While underweighting a security versus a benchmark is a means for a long only manager to generate alpha, hedge funds are able to add additional alpha by monetizing declines in security prices through short positions. The relatively steady decline of the short interest factor for much of this year has contributed to the alpha-rich environment. We believe that this dynamic, in which heavily shorted stocks underperform, benefiting those who hold the short positions, further corroborates our view that fundamentals are driving equity prices.1
2. UNCONSTRAINED VERSUS TRADITIONAL BENCHMARKS
Often, long only manager performance is benchmarked versus traditional market capitalization-weighted indexes, which can lead to performance-chasing behavior, especially in environments where only a handful of stocks contribute a meaningful portion of index-level returns. NVIDIA, for instance, contributed 34.5% of the S&P 500’s return in the first half of 2024. Put simply, long only managers who were not long NVIDIA, likely underperformed their benchmarks. Thus, these benchmark-constrained investors find themselves faced with the decision to either 1) chase index performance by including these market heavyweights, resulting in less active selection alpha, or 2) underperform the market cap- weighted indexes to which they are being compared. Hedge funds are not typically benchmarked versus these same market cap-weighted indexes, making them less susceptible to these same pressures.
For these reasons, we find the current market construct particularly conducive to lower net or market-neutral strategies, with the ability to generate alpha on both the long and short sides of portfolios. Higher net exposure strategies, or those whose performance is benchmarked to market returns, may struggle to generate meaningful alpha given concentration at the index level.
Conclusion
We believe the environment will remain rich with alpha opportunities for hedge funds. Although the Federal Reserve is likely to begin cutting interest rates, we expect base rates to remain higher from a historical standpoint, continuing to support dispersion and stock-picking opportunities. Additionally, looming elections and the potential for changing leadership in the U.S. could create further opportunities for individual stock selection based on policy implications. Plus, broad macroeconomic uncertainty, which drove pronounced bouts of volatility in July and August, illuminates the need for uncorrelated, diversifying sources of return. We remain confident that hedge funds will capitalize on the ongoing opportunity set and that the inclusion of market-neutral strategies may benefit a well-balanced portfolio.
|
Vice President
|
IMPORTANT INFORMATION
Diversification does not eliminate the risk of loss.
The views and opinions and/or analysis expressed are those of the author or the investment team as of the date of preparation of this material and are subject to change at any time without notice due to market or economic conditions and may not necessarily come to pass. Furthermore, the views will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date of publication. The views expressed do not reflect the opinions of all investment personnel at Morgan Stanley Investment Management (MSIM) and its subsidiaries and affiliates (collectively “the Firm”), and may not be reflected in all the strategies and products that the Firm offers.
This material has been prepared on the basis of publicly available information, internally developed data and other third-party sources believed to be reliable. However, no assurances are provided regarding the reliability of such information and the Firm has not sought to independently verify information taken from public and third-party sources.
This material is a general communication, which is not impartial and all information provided has been prepared solely for informational and educational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The information herein has not been based on a consideration of any individual investor circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.
Charts and graphs provided herein are for illustrative purposes only. Past performance is no guarantee of future results.
The indexes are unmanaged and do not include any expenses, fees or sales charges. It is not possible to invest directly in an index. Any index referred to herein is the intellectual property (including registered trademarks) of the applicable licensor. Any product based on an index is in no way sponsored, endorsed, sold or promoted by the applicable licensor and it shall not have any liability with respect thereto.
This material is not a product of Morgan Stanley’s Research Department and should not be regarded as a research material or a recommendation.
The Firm has not authorised financial intermediaries to use and to distribute this material, unless such use and distribution is made in accordance with applicable law and regulation. Additionally, financial intermediaries are required to satisfy themselves that the information in this material is appropriate for any person to whom they provide this material in view of that person’s circumstances and purpose. The Firm shall not be liable for, and accepts no liability for, the use or misuse of this material by any such financial intermediary.
This material may be translated into other languages. Where such a translation is made this English version remains definitive. If there are any discrepancies between the English version and any version of this material in another language, the English version shall prevail.
The whole or any part of this material may not be directly or indirectly reproduced, copied, modified, used to create a derivative work, performed, displayed, published, posted, licensed, framed, distributed or transmitted or any of its contents disclosed to third parties without the Firm’s express written consent. This material may not be linked to unless such hyperlink is for personal and non-commercial use. All information contained herein is proprietary and is protected under copyright and other applicable law.
DISTRIBUTION
This material is only intended for and will only be distributed to persons resident in jurisdictions where such distribution or availability would not be contrary to local laws or regulations.
MSIM, the asset management division of Morgan Stanley (NYSE: MS), and its affiliates have arrangements in place to market each other’s products and services. Each MSIM affiliate is regulated as appropriate in the jurisdiction it operates. MSIM’s affiliates are: Eaton Vance Management (International) Limited, Eaton Vance Advisers International Ltd, Calvert Research and Management, Eaton Vance Management, Parametric Portfolio Associates LLC, and Atlanta Capital Management LLC.
This material has been issued by any one or more of the following entities:
EMEA
This material is for Professional Clients/Accredited Investors only.
In the EU, MSIM and Eaton Vance materials are issued by MSIM Fund Management (Ireland) Limited (“FMIL”). FMIL is regulated by the Central Bank of Ireland and is incorporated in Ireland as a private company limited by shares with company registration number 616661 and has its registered address at 24-26 City Quay, Dublin 2, DO2 NY19, Ireland.
Outside the EU, MSIM materials are issued by Morgan Stanley Investment Management Limited (MSIM Ltd) is authorised and regulated by the Financial Conduct Authority. Registered in England. Registered No. 1981121. Registered Office: 25 Cabot Square, Canary Wharf, London E14 4QA.
In Switzerland, MSIM materials are issued by Morgan Stanley & Co. International plc, London (Zurich Branch) Authorised and regulated by the Eidgenössische Finanzmarktaufsicht (“FINMA”). Registered Office: Beethovenstrasse 33, 8002 Zurich, Switzerland.
Outside the US and EU, Eaton Vance materials are issued by Eaton Vance Management (International) Limited (“EVMI”) 125 Old Broad Street, London, EC2N 1AR, UK, which is authorised and regulated in the United Kingdom by the Financial Conduct Authority.
Italy: MSIM FMIL (Milan Branch), (Sede Secondaria di Milano) Palazzo Serbelloni Corso Venezia, 16 20121 Milano, Italy. The Netherlands: MSIM FMIL (Amsterdam Branch), Rembrandt Tower, 11th Floor Amstelplein 1 1096HA, Netherlands. France: MSIM FMIL (Paris Branch), 61 rue de Monceau 75008 Paris, France. Spain: MSIM FMIL (Madrid Branch), Calle Serrano 55, 28006, Madrid, Spain. Germany: MSIM FMIL Frankfurt Branch, Große Gallusstraße 18, 60312 Frankfurt am Main, Germany (Gattung: Zweigniederlassung (FDI) gem. § 53b KWG). Denmark: MSIM FMIL (Copenhagen Branch), Gorrissen Federspiel, Axel Towers, Axeltorv2, 1609 Copenhagen V, Denmark.
MIDDLE EAST
Dubai: MSIM Ltd (Representative Office, Unit Precinct 3-7th Floor-Unit 701 and 702, Level 7, Gate Precinct Building 3, Dubai International Financial Centre, Dubai, 506501, United Arab Emirates. Telephone: +97 (0)14 709 7158).
This document is distributed in the Dubai International Financial Centre by Morgan Stanley Investment Management Limited (Representative Office), an entity regulated by the Dubai Financial Services Authority (“DFSA”). It is intended for use by professional clients and market counterparties only. This document is not intended for distribution to retail clients, and retail clients should not act upon the information contained in this document.
U.S.
NOT FDIC INSURED | OFFER NO BANK GUARANTEE | MAY LOSE VALUE | NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY | NOT A DEPOSIT
ASIA PACIFIC
Hong Kong: This material is disseminated by Morgan Stanley Asia Limited for use in Hong Kong and shall only be made available to “professional investors” as defined under the Securities and Futures Ordinance of Hong Kong (Cap 571). The contents of this material have not been reviewed nor approved by any regulatory authority including the Securities and Futures Commission in Hong Kong. Accordingly, save where an exemption is available under the relevant law, this material shall not be issued, circulated, distributed, directed at, or made available to, the public in Hong Kong. Singapore: This material is disseminated by Morgan Stanley Investment Management Company and may not be circulated or distributed, whether directly or indirectly, to persons in Singapore other than to (i) an accredited investor (ii) an expert investor or (iii) an institutional investor as defined in Section 4A of the Securities and Futures Act, Chapter 289 of Singapore (“SFA”); or (iv) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. This publication has not been reviewed by the Monetary Authority of Singapore. Australia: This material is provided by Morgan Stanley Investment Management (Australia) Pty Ltd ABN 22122040037, AFSL No. 314182 and its affiliates and does not constitute an offer of interests. Morgan Stanley Investment Management (Australia) Pty Limited arranges for MSIM affiliates to provide financial services to Australian wholesale clients. Interests will only be offered in circumstances under which no disclosure is required under the Corporations Act 2001 (Cth) (the “Corporations Act”). Any offer of interests will not purport to be an offer of interests in circumstances under which disclosure is required under the Corporations Act and will only be made to persons who qualify as a “wholesale client” (as defined in the Corporations Act). This material will not be lodged with the Australian Securities and Investments Commission.
Japan
This material may not be circulated or distributed, whether directly or indirectly, to persons in Japan other than to (i) a professional investor as defined in Article 2 of the Financial Instruments and Exchange Act (“FIEA”) or (ii) otherwise pursuant to, and in accordance with the conditions of, any other allocable provision of the FIEA. This material is disseminated in Japan by Morgan Stanley Investment Management (Japan) Co., Ltd., Registered No. 410 (Director of Kanto Local Finance Bureau (Financial Instruments Firms)), Membership: the Japan Securities Dealers Association, The Investment Trusts Association, Japan, the Japan Investment Advisers Association and the Type II Financial Instruments Firms Association.