2022 was an extremely challenging year for markets, with equities falling into a bear market, bonds declining significantly as interest rates rose, and recessionary fears mounting. This turbulent environment provided a rigorous test for hedge fund managers across strategies. With markets providing little quarter for either long or short positions, generating positive returns was difficult.
By the end, you will have an in-depth understanding of the drivers behind hedge fund performance dispersion in 2022. The year reinforced the merits of proper manager selection, diversification, and risk management. With markets poised to remain challenging, scrutinizing manager positioning and performance attribution will be more crucial than ever for investors.
Hedge Fund Performance Overview
After a very strong 2021, hedge fund performance diverged widely 2022 as markets entered a regime of significantly higher volatility and shifting correlations across asset classes. Key observations include:
- Divergent returns – There was high dispersion between top and bottom-performing hedge funds in 2022.
- Few winners – Only around 22% of hedge funds generated positive returns, with most managers losing money.
- Strategy bifurcation – Macro, commodity trading advisors (CTAs), and relative value strategies performed well, while equity and credit focused funds struggled.
- High volatility – Realized volatility was 2-3x higher than in recent years, challenging hedging strategies.
- Poor proxies – Many historically reliable hedges failed to provide protection during market sell-offs.
- Liquidity challenges – Deleveraging and position unwind amplified market moves and volatility.
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Overall, 2022 presented an exceptionally difficult environment for hedge fund managers to navigate and underscored the merits of strategies with low equity beta and macro flexibility.
Best Performing Hedge Fund Strategies
Several hedge fund strategies managed to generate positive returns in 2022 by capitalizing on surging inflation, rising rates, and market dislocations:
Global Macro – This was the top-performing strategy, with discretionary macro managers up 12% by shorting bonds and going long energy and agriculture commodities earlier in the year. Systematic macro also performed well.
Managed Futures – Systematic trend followers saw strong performance, with CTAs up 11% through long bonds, short equities, long dollars, and short commodities positioning.
Relative Value – These strategies produced gains of 4% from fixed income arb trading heightened yield curve volatility and credit arb capitalizing on wider corporate spreads.
Event-Driven – Managers focusing on energy/commodity-related events and those short disrupted deals outperformed, returning 2% to 5% for the year.
Market Neutral – Equity market neutral strategies delivered modestly positive returns driven by their lower directional exposures and volatility trading gains.
Positioning correctly early in the major regime change and trading market dislocations paid off for flexible macro and systematic strategies in 2022.
Hedge Fund Strategies That Struggled
Conversely, strategies with long equity exposure or exposure to spread tightening generally incurred sizable losses:
Equity Long/Short – Plunging equity markets led to losses of 8% on average for equity long/short. Both longs and shorts lost money with elevated correlation.
Credit – Strategies focused on high-yield bonds and leveraged loans saw double-digit losses from credit spread widening. Difficult long and short positioning.
Multi-Strategy – With exposure across struggling equity and credit strategies, losses averaged 6% for multi-strategy hedge funds.
Risk Arb – These managers lost 4% on average as many higher-risk mergers deals collapsed in the face of rising uncertainty.
Fixed Income Arb – Rising rates created losses for many fixed income arbitrageurs, especially mortgage-focused. Making money on both longs and shorts was challenging.
Distressed Credit – Despite widening spreads, distressed managers lost 3% as long positions dropped along with overall markets. Shorts also lost money.
The lack of profitable opportunities for both long and short trades across assets like equities, credit, and mortgages led to broad-based losses.
Analysis of Top Performing “Winner” Hedge Funds in 2022
The minority of hedge funds that generated strong positive returns in 2022 typically shared similar attributes:
- Dynamic positioning – Winners made major portfolio shifts starting in Q4 2021 to position conservatively for rising volatility.
- Inflation beneficiaries – They targeted long exposure to inflation beneficiaries like commodities and real assets early.
- Low equity beta – Winners maintained low equity exposure and credit duration throughout 2022.
- Curve positioning – Getting long the front-end and short the back-end of yield curves was profitable as curves flattened.
- Short bonds – Short positioning across developed market bonds contributed significantly to performance.
- Trend following – Systematic trend strategies quickly flipped long bonds and dollar, short equities and commodities.
- Prudent risk taking – Selective risk taking in dislocated opportunities like AAA CLOs and energy assets added gains for some managers.
In general, top performing hedge funds maintained a defensive macro positioning, low equity and credit directionality, and actively traded market dislocations. This enabled sizable outperformance at lower risk than benchmark indices.
Factors Behind Hedge Fund “Losers” in 2022
On the flip side, several factors contributed to poor performance for losing managers:
- Equity exposure – Many losing managers entered 2022 with net long equity positioning, which detracted massively from performance.
- Credit exposure – Net long high yield bonds and CLOs generated large losses as spreads gapped wider.
- Leverage – Higher portfolio leverage amplified losses on the long side as equity and credit markets sold off aggressively.
- Crowded trades – Trades like long metaverse/crypto stocks and short dollar proved unprofitable as consensus positioning unwound violently.
- Style drift – Some normally defensive strategies drifted to a risk on stance, getting caught wrong-footed by the regime change.
- Inflexibility – Many losing funds maintained static positioning rather than responding decisively to rapidly changing market conditions.
- Short squeezes – Forced deleveraging led to violent short squeezes and lack of actionable short opportunities.
The combination of excess directional risk, overleverage, and lack of defensive flexibility proved disastrous for many hedge fund managers in 2022’s challenging environment.
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Hedge Fund Failure Rates in 2022
While aggregate figures are not yet available, hedge fund failure and closure rates likely increased notably in 2022 based on prior periods of significant market stress:
- Failure triggers – Major losses, investor withdrawals, gates or side pockets, and loss of financing can trigger hedge fund failures. All escalated in 2022.
- Prior periods – Failure rates jumped after major events like the GFC and tech bubble bursting, suggesting a similar dynamic played out in 2022.
- Smaller funds – Smaller hedge funds tend to close at higher rates given their lack resources to ride out challenging periods. Their closure rate likely rose in 2022.
- Star managers – Even elite “star” managers can close after losses if investors withdraw capital and they face fund economics challenges from lower fees.
- Longer drawdowns – Research shows extended drawdowns of 12 months or more substantially increase hedge fund closure rates. Drawdowns lengthened in 2022.
While 2022 closure figures remain unclear, history shows major market dislocations result in a significantly higher frequency of hedge fund failures. This will shake up the competitive landscape in terms of manager roster and assets in coming years.
Hedge Fund Performance Outlook for 2023
In terms of positioning for 2023, the hedge fund landscape shapes up as:
- Cautious stance – Most managers remain defensive given economic uncertainty and high volatility. Equity and credit exposures are low.
- Macro flexibility – Winners are positioned for tactical trades but maintain dry powder to pivot across bonds, currencies, commodities, and equities as data shifts.
- Event focus – After a lull in corporate events, deal activity appears likely to increase. Managers are preparing for more opportunities.
- Relative value – Trades across fixed income, credit, and currencies remain attractive based on dislocations and steepness of yield curves.
- Shorts – Managers see emerging short opportunities in cyclical sectors and companies with overleveraged balance sheets vulnerable to higher rates.
- Trend following – Systematic macro strategies will continue benefitting from cross-asset volatility and persistent trends across rates, FX, equities, and commodities.
Positioning remains cautious but nimble among hedge funds entering 2023, with macro flexibility, relative value, and re-emerging events seen as promising sources of returns.
Key Lessons Learned for Investors
The high dispersion of hedge fund performance in 2022 reinforced key lessons for manager selection and portfolio construction:
- Low correlation – Ensure the portfolio combines lowly correlated strategies and manages overall equity/credit directionality.
- Manager selection – Thoroughly assess a manager’s flexibility, risk limits, and ability to perform in volatile, low return environments.
- Diversification – Maintain broad diversification by strategy, sector, and geographic exposures rather than overconcentration.
- Liquidity management – Gauge each manager’s liquidity terms relative to underlying market liquidity in stressed scenarios before investing.
- Tail hedging – Consider small exposures to strategies that hedge extreme left tail risks like structured volatility trading.
- Risk budgeting – Size positions according to risk rather than allocating equal capital across funds.
By focusing more intensely on diversification, manager selection, and risk management, investors can improve portfolio resilience in future challenging markets akin to 2022.
To Recap
2022 proved an exceptionally challenging year for hedge fund performance, with high dispersion between top and bottom performers. Strategies like macro and relative value fared best due to lower equity and credit market exposures and flexibility to position long volatility and short bonds. Meanwhile, long/short equity and credit strategies generally incurred sizable losses from adverse positioning.
Analyzing the drivers behind winners and losers provides valuable insights for manager selection, portfolio construction, and risk management. With markets likely to remain volatile in 2023, scrutinizing hedge fund positioning and performance attribution takes on heightened importance for investors seeking positive absolute returns in treacherous markets.
Frequently Asked Questions
How did most hedge funds perform in 2022?
Most hedge funds generated negative returns in 2022, with only around 22% producing positive performance. Macro, managed futures, and relative value strategies performed best, while equity and credit focused funds did poorly with losses averaging 6% to 10%.
What were the best-performing strategies in 2022?
Global macro, managed futures, relative value, and event-driven managers focusing on deal catalysts and short opportunities delivered the best performance. These strategies maintained low equity exposure and profited from rising rates and volatility.
What types of hedge funds struggled the most in 2022?
Long/short equity, credit, multi-strategy, risk arbitrage, and fixed-income arbitrage managers performed poorly in 2022. They incurred losses from long equity and credit positioning as both markets tumbled. Inflexibility and crowding exacerbated losses.
Did hedge fund failure rates increase in 2022?
While final data remains unavailable, hedge fund failure rates likely increased substantially in 2022 given losses across strategies, liquidity strains, and redemption pressures. Periods of major market stress typically entail heightened failure rates.
How are most hedge funds positioned early in 2023?
Hedge fund positioning remains cautious entering 2023. Managers are underweight equities and credit with the flexibility to pivot across macro markets. There is a focus on relative value trades, events, and selective shorts. Trend-following strategies also look well-positioned.
In another related article, A Beginners Guide to Hedge Fund Investing: What You Need to Know
