The hedge fund industry as a whole has lost 5.36% for the year to May, but one quarter of funds are up by an average of 20%, according to eVestment, which is owned by Nasdaq. Where are these returns coming from and how is the opportunity set evolving?

In equity long/short, the best positioned funds include some technology-oriented ones that have for many years been long of disruptive technology trends, such as ecommerce and payments, that have been accelerated by Covid-19. There are also a variety of equity hedge funds that have been adept at tactical trading, battening down the hatches in February and March and then rebuilding exposure at lower levels. Equity managers are confident about picking winners and losers in a new climate that will certainly involve more regulation of many industries, and at some stage is likely to see more taxation to repay government borrowing.

After the strongest equity rally in decades, and huge rises in other risk assets, fundamental long and short name selection is coming to the fore. In US corporate credit, defaults are now forecast to reach over 10% yet recovery rates on CDS have plummeted to as low as two cents on the dollar. Therefore, credit spreads compressed by central bank buying might not even cover expected default losses, and default cycles tend to last multiple years. There could be a long runway of opportunity for distressed debt.

There should also be a greater supply of emerging market sovereign defaults. In recent years, these have been rare occurrences (Argentina, the Seychelles, Ecuador and Lebanon) but it is now expected that restructurings, debt relief and moratoriums could affect many more countries. Managers who choose not to accept restructurings and hold out can end up pursuing awards through the courts or even foreclosing on ships.

Alternative credit strategies are also being sought after as a haven from volatility. It is too early to gauge the level of default losses that direct lending funds may experience, but some lending strategies are proving resilient, including a Swiss trade finance manager specializing in essential agricultural commodities, profiled in this issue. Elsewhere in commodities, the roll yield has always been important for all kinds of investors and the shock of Covid-19 has thrown forward curves out of kilter. Some relative value traders looking at calendar spreads have done particularly well this year.

Most hedge funds apply alternative strategies to traditional asset classes, but a handful of them are also trading alternative asset classes, such as cryptocurrencies, where it is also possible to generate uncorrelated returns – from either a long only or a relative value approach. In this issue we profile a manager, Nickel Digital, offering both strategies. Currently we are inclined to categorise digital currencies as “alternative”, but they may be rapidly moving into the mainstream. Custodian, Fidelity Digital Assets, recently conducted a survey of 800 institutional investors in the US and Europe, including financial advisors, family offices, pensions, crypto and traditional hedge funds, high net worth investors, and endowments and foundations. It found that 60% believe digital assets should be part of their portfolios, and 36% are already invested in them.