Hedge funds could operate as fixed income proxies amid a bumpy global monetary policy descent to ‘normal’ altitude, according to Mercer.
In a new paper outlining five strategies for ‘financial intermediaries’ as volatility mounts, Mercer highlights hedge funds as “one of the few areas with foreseeable tailwinds, unique diversification benefits and independence from the stock–bond correlation dynamics”.
“We believe a hedge fund mandate can serve as a fixed-income alternative, delivering risk reduction while preserving long-term capital appreciation,” the report says.
Mercer says while interest rates have eased since the post-COVID inflation burst, the uncertain path ahead for monetary settings imply “a need to increase diversification in portfolios”.
“Hedge funds may be well suited to the current environment due to their ability to capitalize on volatility or dislocations resulting from uncertainty,” the paper says. “Furthermore, those absolute returns can benefit from higher cash rates today due to the implicit and explicit cash components embedded in the return structure.”
But as well as exercising due care with manager selection, Mercer recommends investors follow a number of ‘guiding principles’ when allocating to hedge funds such as weighing-up “both sides of the balance sheet and types of risk exposure taken”.
While Mercer has long favoured an exposure to hedge funds, the highly diverse global sector has remained static over the last few years.
For example, recent research from UK-based firm, Aurum, found the now US$3.1 trillion sector saw “net outflows from redemptions” during 2024 despite reporting its best calendar-year performance in more than a decade.
“… total hedge fund industry assets have risen moderately due to positive P&L generation… that has primarily been driven by equity [long/short] and multi-strategy with other contributions coming from all other strategies,” the Aurum study says.
Regardless of uncertainty surrounding the ultimate destination and trajectory of interest rates, Mercer says a return to more ‘normal’ monetary conditions augurs well for diversified investors.
The new higher-rate normal will be “one that lacks free lunches, promotes free capital markets and capital allocation, enforces a real cost of capital, and better aligns with efficient frontier principles”, the paper says.
Aside from hedge funds, Mercer says financial intermediaries should consider allocating to ‘semi liquid’ private markets strategies, ‘next generation’ infrastructure, emerging markets equities and actively managed exchange-traded funds.
Mercer NZ recently introduced an exposure to private credit in its KiwiSaver scheme.