The BlackRock Investment Institute (BII) published a new paper, entitled “More room for hedge funds,” which delves into why hedge funds are emerging as a key tool in portfolios for harnessing returns in today's more volatile macro environment.
The BII believes some investors can hold up to 5 percentage points more in hedge funds today than they did before 2020.
Key reasons:
- Long-term macro anchors are adrift. Long-term macro anchors that were central to building portfolios for decades – like stable growth, contained inflation expectations and fiscal discipline – are lost as the world undergoes a transformation.
- Today's bigger role for active strategies. This environment has proven better than the prior decade for achieving above-benchmark returns, or alpha. Top-performing U.S. equity fund managers have delivered greater alpha and reduced the drag of macro risk on performance since 2020.
- Deliberately managing macro risk matters more today. Static exposures to factors – like growth, inflation or the value equity style factor – are now a drag on portfolio returns. We see greater potential reward for hedge fund strategies that aim to exploit shifts in the economic environment or those that deliberately minimize macro risk to favor security-specific risk instead.
BlackRock manages $80bn in client assets through hedge funds globally, and is one of the top 10 hedge fund managers (data as of March 31, 2025).
Summary
- This is the first part of a portfolio construction series rethinking the “neutral” multi-asset portfolio allocation that reflects a world without macro anchors and a broadened investment opportunity set.
- Today’s environment is an evolution of the new regime of transformation we have been in for some years. Mega forces – structural shifts like geopolitical fragmentation – are reshaping economies. The ensuing transformation could lead to many very different potential outcomes for growth, inflation and government debt and deficits.
- The loss of long-term macro anchors – like stable growth, contained inflation expectations and fiscal discipline – that have underpinned long-term asset allocation for decades defines this new regime. That underscores why deliberately managing exposure to fluctuations in factors like growth and inflation – macro risk – matters more now.
- Static exposures to factors – like growth, inflation or the value equity style factor – are now a drag on portfolio returns. That’s a sea change from the decade following the 2008 global financial crisis. Unintended factor exposures could be more costly today, we find, even though they were arguably ignorable before. We find that top-performing active managers capable of managing or harnessing that macro risk are better rewarded today.
- Yet we believe this environment of transformation is better than the prior decade for achieving above-benchmark returns, or alpha. That warrants a bigger role for active strategies in multi-asset portfolios. We find that top-performing U.S. equity fund managers have delivered greater alpha and reduced the drag of macro risk on performance since 2020.
- We see hedge funds emerging as a key tool in portfolio construction as a result. Our research finds that top-performing hedge funds, especially macro hedge funds that aim to exploit shifts in the economic environment, have delivered greater excess returns since the pandemic. We also see more opportunity for security selection that can outperform markets – a potentially differentiated source of return in portfolios – rewarding those who deliberately minimize macro risk to favor security-specific risk instead. We find the risk of future returns from certain macro hedge fund strategies is lower than that for developed market public equities in a multi-asset portfolio.
- We think that justifies boosting allocations to hedge fund strategies in portfolios. Investors will have unique risk and return targets, with different governance constraints – including the cost of overseeing managers. Yet holding all risk preferences and governance constraints equal, we believe some investors can hold up to 5 percentage points more in hedge funds today than they did before 2020.
- We argue for sizing hedge fund allocations by considering client-specific liquidity, governance and risk constraints over broad asset class labels. We think investors should size allocations to hedge funds based on their unique features – not simply as another asset grouped with private markets in an “alternatives” bucket. One way to fund the increase to hedge funds would be by trimming developed market government bonds and equities, depending on the level of risk being added to the portfolio, with no change to the private market allocation.
Manager skill matters
In February 2024 we laid out our case for why active strategies could play a bigger role in portfolios today, arguing that portfolio manager skill – the ability to consistently outperform peers – is central to capturing the greater potential for alpha in today’s more volatile macro and market regime. We think that volatility reflects the economic transformation underway that is being driven by mega forces – big structural shifts such as artificial intelligence (AI). That means there’s greater uncertainty about the future path of economies now, with many very different potential long-term outcomes from this transformation.
A core feature of today’s regime is the loss of long-term macro anchors – expectations for stable growth, contained inflation expectations and fiscal discipline – that investors could rely on to drive long-term asset returns. It underpins the greater long-term economic uncertainty that is driving greater dispersion in equity returns. See the left chart. The average dispersion of individual stock returns in the S&P 500 surged in 2020 during the pandemic-induced volatility – and has stayed elevated since then relative to the dispersion seen in the decade after the global financial crisis (GFC).
We think this more volatile environment that’s driving elevated dispersion can bode well for skilled fund managers to deliver greater active returns, or alpha. We define skill as manager performance that lands in the top 25%, or top quartile, among all alpha-seeking portfolio managers. Our analysis shows that the alpha generated for a manager with skill is greater than it used to be. See the right chart. Top-performing U.S. equity portfolio managers have delivered more alpha since 2020 (the left red bars) but the average manager has not become more skilful – the excess returns for the average manager haven’t changed. That means the reward for being skilful is greater now.
Some reasons why? Lost long-term macro anchors means investors need to make big calls about the future path of the economy when learning new information. Getting those calls right requires insight that skilled managers may have. Insight on how the economic transformation will evolve – and on the sectors, industries and companies that stand to benefit – may provide an edge for some managers.
But the loss of long-term macro anchors means investors must be more deliberate about the macro risk they take. When the macro environment was more stable, persistent factor exposures – such as to growth, inflation or the value style factor – typically didn’t hurt portfolios. That’s no longer the case today. See the green bars in the right chart. Static factor exposures have become a bigger drag on active returns, particularly for the average fund manager. That underlines why macro risk must be managed or harnessed more deliberately, in our view. Skilled portfolio managers have minimized the drag from macro risk compared with the average manager. So portfolio manager skill matters even more today.
Read the full paper here by BlackRock
