Hedge Fund Strategy Outlook: Second quarter 2025

Just three months ago, we assessed that the investment climate was best characterized by high economic uncertainty, increased geopolitical risks, elevated valuations and tight credit spreads. Fast forward to today, both economic uncertainty and geopolitical risks are even HIGHER, valuations have begun to recede and credit spreads are widening. However, Warren Buffett is not on a buying spree and the credit world is not distressed, YET. One could argue that US President Trump set these animal spirits in motion; others would say that the world order is being upset over a long cycle (Ray Dalio) and others are pointing to unsustainable levels of debt. Regardless of the exact reason, we expect sustained market volatility and dispersion, fleeting liquidity during surprise news announcements and crowded unwinds. From a hedge fund active investment management point of view, this environment provides both auspicious opportunities and large risks. We expect to see larger divergences in manager performance within the same sector due to increased volatility. Investors need to be diversified, liquid, opportunistic and patient.

Strategy highlights

1. Relative value: Increased volatility and dispersion are creating a better opportunity set for relative value strategies that may be able to capitalize on pricing inefficiencies within and across asset classes.
2. Discretionary global macro: Policy implementation may help establish market trends and themes in the coming months, creating potentially attractive opportunities for forward-looking managers.
3. Commodities relative value: Trade policy announcements have helped create geographic arbitrage opportunities, though headline risks abound as macro factors are likely to continue to be a key driver of commodity prices.
    

Macro themes we are discussing

Just three months ago, we assessed that the investment climate was best characterized by high economic uncertainty, increased geopolitical risks, elevated valuations, and tight credit spreads. Fast forward to today, both economic uncertainty and geopolitical risks are even HIGHER, valuations have begun to recede, and credit spreads are widening. However, Warren Buffett is not on a buying spree and the credit world is not distressed, YET. One could argue that US President Trump set these animal spirits in motion, others would say that the world order is being upset over a long cycle (Ray Dalio), and others are pointing to unsustainable levels of debt. Regardless of the exact reason, we expect sustained market volatility and dispersion, fleeting liquidity during surprise news announcements, and crowded unwinds.

Given that the current market environment can still be characterized by high economic uncertainty, increased geopolitical risks, elevated valuations, and tight credit spreads, even with the hints of changing tides we noted above, we continue to believe the outlook for hedge fund strategies is very favorable. These factors are expected to lead to higher volatility across asset classes and increased dispersion within various sectors, particularly as political and economic influences impact sectors differently. This environment is particularly favorable for both relative value and active strategies that can be appreciated from being dynamic, non-directional, and agile.

We are optimistic about discretionary global macro strategies due to geopolitical uncertainty, changing interest rates, and shifts in foreign exchange rates. Relative value strategies appear promising, leveraging corporate events and asset class dispersion. Volatility and risk-mitigation strategies also offer potential insulation and diversification from traditional market risks.

Flexible hedge fund strategies that can take advantage of these market conditions have the potential to create significant opportunities for savvy investors.

Q2 2025 outlook: Strategy highlights

Relative value

Relative value strategies have an advantage over directional investment styles at a time when the likely direction of markets is harder to predict. This challenge is particularly pronounced during inflection points. When there is a high degree of policy and economic uncertainty, there are strong tailwinds for some assets, and potentially excessive valuations for others. These uncertainties are beginning to be realized in the pricing of volatility across major asset classes, as can be seen in the following chart. While volatility is generally considered a risk factor for directional strategies, it in fact may present opportunities for managers that can capitalize on it through active trading in strategies such as volatility arbitrage, convertible bonds, and fixed income relative value.

Discretionary global macro

Many macro traders have begun to question the US exceptionalism theme that has prevailed for many years. General policy uncertainty in the United States and a relatively dramatic shift in fiscal policy in Europe have been some of the many catalysts for some investors to begin shifting their portfolio allocations between regions. A rebalancing from the last few years’ winners toward the laggards could have important implications for global equities and foreign exchange (FX) markets. The recent outperformance of European equities and FX markets reflect some of that shift, though there is still some uncertainty as to whether this is the beginning of a long-term trend or a short-term move. Regional dispersion like this can be a boon for many macro managers, and the prospect for ongoing shifts in macro policy could help create an attractive opportunity set going forward.

Commodities relative value

Changes in trade policy have been an important driver of commodity prices recently. The expectation for, or announcement of, various tariffs has helped create interesting divergences across markets. Copper prices have rallied recently for a variety of reasons, but it is the widening spread between US and UK futures markets that has captured the focus of many relative value traders. The two markets can have minor divergences at any given time but have historically traded relatively closely in line. The unusually wide spread reflects surging demand for the metal in the United States before tariffs are implemented or even formally announced. A relative value trader betting on tariffs could have profited from taking long positions in Comex¹ copper in the United States and offsetting shorts in London Metal Exchange (LME) copper in the United Kingdom. Some managers may view the unusually wide spread as an opportunity for mean reversion, placing bets that the prices will converge again in time. Going forward, the rapidly evolving global trade landscape may continue to create a fertile opportunity set for commodity traders, even without taking significant directional risk.