Given that the current market environment is characterized by high economic uncertainty, increased geopolitical risks, elevated valuations and tight credit spreads, we believe the outlook for hedge fund strategies in 2025 is very favorable. These factors are expected to lead to higher volatility across asset classes and increased dispersion within various sectors, as political and economic influences impact sectors differently.
Strategy highlights
- Long/short equity: Deal activity will likely accelerate in 2025. Long/short equity managers should benefit as corporate events create complexities that serve as opportunities for investors that are less constrained and better equipped to analyze these situations.
- Discretionary global macro: The change in US administration is likely to come with significant policy changes, especially related to taxation, regulation and immigration. Macro managers may find a rich opportunity set as these changes influence domestic and international economies.
- Credit: We believe the go-forward environment will be characterized by higher dispersion and volatility, which should be particularly beneficial for credit managers who can remain nimble, active, and can express their ideas both long and short.
|
Strategy |
Outlook |
|
Long/short equity |
Neutral but improving given higher sustained levels of dispersion. Fundamentals are driving price action. Artificial intelligence (AI) represents a massive product cycle to create winners and losers. |
|
Relative value |
Outlook remains neutral, with some strategies improving marginally due to a possible pickup in dispersion across and within asset classes, as well as higher volatility of volatility due to greater monetary, fiscal and geopolitical uncertainty. |
|
Event-driven |
Improved outlook, reflecting lower regulatory risks and the expectation for a pickup in event-driven opportunities such as activism, M&A, spinoffs and other growth-oriented corporate activities. |
|
Credit |
Underweight directional strategies given tight spreads and the potential for dislocations. More positive on long/short credit investment strategies, which can benefit from an increase in dispersion across winners and losers based on changing regulatory and fiscal regimes. |
|
Global macro |
The opportunity set should remain rich for macro-focused managers, as regional economies are showing signs of divergence and as the new administration takes office in the United States—potentially introducing new trends and themes for managers to capitalize on. Still, risks may persist if geopolitical tensions rise or policy implementation is not smooth. |
|
Commodities |
Relative value opportunities continue to appear attractive, while directional strategies may remain challenged by range-bound trading. Managers are focused on the risks and opportunities that could emerge from several macro catalysts, including a potential resolution of the Ukraine war or growth surprises in the United States, Europe, or China. |
|
Insurance-linked securities (ILS) |
Following the continued spread tightening that was a dominant theme in the second half of 2024, cat bonds printed another year of record issuance. This momentum looks to carry into 2025, with several transactions looking to settle in the first weeks of the year and more anticipated by mid-January. Overall, the market appears relatively healthy as the dense pipeline of issuance continues to absorb cash. |
Macro themes we are discussing
Given that the current market environment is characterized by high economic uncertainty, increased geopolitical risks, elevated valuations, and tight credit spreads, we believe the outlook for hedge fund strategies in 2025 is very favorable. These factors are expected to lead to higher volatility across asset classes and increased dispersion within various sectors, as political and economic influences impact sectors differently. This environment is particularly favorable for active strategies that can benefit from being dynamic, non-directional, and agile.
We have a positive outlook for discretionary global macro strategies, which are well positioned to benefit from geopolitical uncertainty, changing interest-rate regimes, and secular shifts in foreign exchange rates. Relative value strategies also show promise, as they can capitalize on corporate events and dispersion across asset classes and sectors. Additionally, volatility and risk-mitigation strategies present a very attractive entry point due to low VIX levels (and high valuations), despite the potentially elevated uncertainty and the risk of policy missteps as we head into 2025.
Overall, the combination of these market conditions and the inherent flexibility of hedge fund strategies suggests that 2025 could be a year of significant opportunities for investors who are able to navigate the complexities of the market effectively.
Q1 2025 outlook: Strategy highlights
Long/short equity
Global deal volumes rebounded in 2024, especially toward the end of the year. Market participants expect that momentum to continue into 2025, with activity likely accelerating under the incoming Trump administration. Long/short equity managers should benefit from higher levels of activity for a few reasons. Most simply, merger and acquisition (M&A) transactions serve as a catalyst for managers to unlock value in specific positions. More generally, corporate events of all types create complexities and inefficiencies that serve as opportunities for investors that are less constrained and better equipped to analyze these situations (i.e. hedge funds). In fact, this is often self-fulfilling. A deal forces management teams at other companies in the industry to rethink their position and respond in some way, whether that be their own transaction, a change in capital allocation, or some other strategy. Analysts who specialize in those companies will have a better handle on the path forward. Finally, deals also create volatility as market participants react to news with varying perceptions of the likelihood of success.
Exhibit 1: Global Transaction Volumes Bounce Back in 2024
2014-2024
Source: Bloomberg. As of December 31, 2024. Important data provider notices and terms available at www.franklintempletondatasources.com.
Discretionary global macro
Divergences in economic strength, and therefore, in policy paths, have always contributed to notable moves in currency markets. Euro/US dollar (EURUSD), which can be used as a single measure of the relative strength of the European economy versus the United States, appears to have been trading in a range since late 2022. A new administration taking office in the United States, signs of shifting political winds in various European countries, and notable differences in growth trajectories between the United States and Europe could help push the exchange rate out of this range. Away from this singular benchmark rate, several macro managers have been discussing the US dollar more broadly, with some focusing not just on relative strength or valuation, but also on rising fiscal deficits and the role of the currency in global trade and geopolitical order. New macro trends and narratives may play out in a variety of markets, with several macro managers increasingly excited about the opportunity set for foreign exchange.
Exhibit 2: EURUSD Exchange Rate
December 31, 2017–December 20, 2024
Source: Bloomberg. Important data provider notices and terms available at www.franklintempletondatasources.com.
Credit
The significant political changes in major economies across the globe are likely to lead to a material dispersion of outcomes for credit issuers, depending on factors such as geography, sector, credit quality and regulatory framework. A small preview of that occurred in November, when following the US election there was a significant amount of dispersion across a wide range of sectors, reflecting investor repositioning in response to expected future regulatory changes. The new US administration is not yet in place, their policies are undefined, and even when confirmed, they will have to contend with economic and political realities. We believe this environment will be characterized by higher dispersion and volatility, which should be particularly beneficial for credit managers who can remain nimble, active, and can express their ideas both long and short.
Exhibit 3: High-Yield Spread Change the Day After Last US Election
Day Over Day High Yield Spread Change
November 8, 2024
Sources: Bloomberg, Barclays Research. Important data provider notices and terms available at www.franklintempletondatasources.com.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. The allocation of assets among different strategies, asset classes and investments may not prove beneficial or produce the desired results. Some subadvisors may have little or no experience managing the assets of a registered investment company. International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. Derivative instruments can be illiquid, may disproportionately increase losses, and have a potentially large impact on performance.
Equity securities are subject to price fluctuation and possible loss of principal.
Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Changes in the credit rating of a bond, or in the credit rating or financial strength of a bond’s issuer, insurer or guarantor, may affect the bond’s value. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default. Currency management strategies could result in losses to the fund if currencies do not perform as expected.
Commodity-related investments are subject to additional risks such as commodity index volatility, investor speculation, interest rates, weather, tax and regulatory developments. Short selling is a speculative strategy. Unlike the possible loss on a security that is purchased, there is no limit on the amount of loss on an appreciating security that is sold short. Investments in companies engaged in mergers, reorganizations or liquidations also involve special risks as pending deals may not be completed on time or on favorable terms. Liquidity risk exists when securities or other investments become more difficult to sell, or are unable to be sold, at the price at which they have been valued.
Active management does not ensure gains or protect against market declines.