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Today, we’ll be presenting the annual predictions of the most prominent trends in the global hedge fund industry for the year 2023. These are based on extensive discussions with over 2,000 investors, including hundreds of fund organizations. They predict that the economy will continue growing and interest rates will rise. Due to the dynamic nature of the industry, both investors and managers can benefit from being prepared for the changes that will happen in the future.


Increase in expected returns for a diversified hedge fund portfolio 

According to our projections, the risk-free rate is expected to rise to around 4%, which will lead to higher returns for investors in a diversified fund portfolio. Higher interest rates will have a significant impact on the demand for certain types of hedge fund strategies. Because of this, investors will be more focused on the expected returns of these strategies over the risk-free limit. The increase in interest rates will also reduce the demand for low-volatility strategies such as the high Sharpe Ratio. These strategies typically have lower minimum hurdle returns.


Increase in demand for strategies with excess collateral

People tend to associate falling asset values with rising interest rates. The inverse relationship between bond and interest rates can also be utilized in equity valuations. Many investors believe that a company’s intrinsic value is its present value, and if its earnings are discounted at higher rates, the stock price will go down.


However, rising short-term interest rates can be beneficial for certain types of hedge fund strategies. They can help investors maintain their returns over time by holding large cash and short-term fixed-income positions.


Redefine risk

The rising interest rates and a recession in 2023 are expected to cause performance tail risk to increase. This will cause investors to rethink how they measure and view risk. Historically, institutional investors have been seeking to maximize the expected returns of multi-asset class portfolios.


Understanding the various factors that affect the returns and volatility of different asset classes is necessary in order to determine optimal allocations. These include historical returns, economic forecasts, and current valuations. Using these assumptions can be used in optimization models to determine the optimal asset allocation.


Unfortunately, using these models has resulted in portfolios experiencing greater risk than they anticipated. During market sell-offs, the correlations and volatility of different asset classes can increase dramatically, which can lead to significant losses. The true risk of an asset allocation is computed by taking into account the changes in the correlations and volatility of the underlying strategies.


Using these models can help accurately forecast the impact a sell-off would have on a portfolio. Although most strategies are short-volatility, less-liquid ones tend to carry the greatest tail risk due to their lack of liquidity.