Warning To Hedge Funds Amid Blackrock’s Advice To Boost Allocations: Beware The Liquidity Trap

BlackRock is advising investors to boost their hedge fund allocations by up to five percentage points versus what they held before 2020 - assuming risk preferences and governance constraints are kept the same. However, larger amounts of capital not only mean bigger positions but also increased leverage and significantly bigger margin demands. One expert recommends that hedge funds must rethink the way they manage collateral to avoid a liquidity trap.

BlackRock’s recommendation

BlackRock noted in its report that we’re currently in a period of economic transformation marked by structural shifts such as geopolitical fragmentation. As a result, the range of potential outcomes for growth, inflation, and government debt and deficits is wide.

According to BlackRock, static exposures to factors such as growth, value or inflation are now weighing on portfolio returns, marking a significant shift from the 10 years after the 2008 global financial crisis. In its research, the firm found that the best-performing U.S. equity fund managers have generated more alpha while slashing the weight of macro risk on performance since 2020. Thus, BlackRock is calling for a greater role for active strategies, specifically, hedge funds, in multi-asset portfolios.

Macro funds to be the biggest winners

In particular, the firm said that macro hedge funds aiming to take advantage of the shifting economic environment are the greatest winners. As a result, BlackRock sees more opportunity for security selection capable of outperforming markets, which will reward those who aim to minimize macro risk in favor of security-specific risk.

To fund the increased allocation to hedge funds, the firm suggests investors trim exposure to developed market government bonds and equities, depending on how much risk is being added to the portfolio, without changing allocations to the private markets.

In an interview with Hedge Fund Alpha, Jo Burnham of OpenGamma shared the problems posed by margin requirements related to BlackRock’s advice and the complexity and difficulty of dealing with these issues.

Also see: Tiger Great-Grand Cub On The Prowl For New Managers For Its Alpha Capture Platform

Why the recommendation?

Explaining the reasoning why BlackRock is advising investors to boost allocations to hedge funds, Burnham said investors are generally worried about the impacts of volatility and the potential for black swan events. She also cited the markets’ current penchant for sudden reversals this year.