Hedge Fund Strategy Outlook: First quarter 2025

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

1. 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.
2. 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.
3. 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.
    

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.

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.

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.