08.26.2011
By Terry Flanagan

Probing the Marketplace

In light of the recent volatility experienced by the U.S. equities market, buy and hold is dead, according to many market participants. Plain vanilla strategies are especially defunct in the hedge fund environment; many of whom see volatility plays as opportunities to gain traction from investors.

“What we’re seeing is that people are moving away from managers that implement simple buy and hold strategies,” said Don Steinbrugge, managing member at hedge fund marketer Agecroft Partners. “We’ve seen since 2008, widening beta trades. Managers with opportunities are those that can trade their portfolio.”

In the fixed income world, hedge funds find strategies involving distressed debt, emerging market debt, and convertible bond arbitrage are most profitable, according to Steinbrugge. “Most of these strategies have done well over the past since 2008 as spreads have tightened significantly. Hedge funds need to remain focused on the less efficient places in the marketplace.”

Steinbrugge also highlighted opportunities in structured credit and products, such as mortgage derivatives. “Firms that trade these products are looking for inefficiencies, and they’re firms that invest in sophisticated, quantitative tools. The traders have strong, quantitative backgrounds in the mortgage derivative space—they can add a lot of value if they’re able to price securities quickly,” he told Markets Media.

“As volatility increases, the way to make money in fixed income hedge fund strategies become about trading, and that means you need to have a very strong knowledge of products, can quantify things quickly and invest in analytics,” Steinbrugge said.

Although most market participants found that the volatility experienced in the beginning of August was fleeting, illustrated by “no pickup in redemptions,” Steinbrugge feels that long term volatility is here to stay.

“The major Western economies are experiencing large deficits, and it’s going to take a long time for governments to work themselves out of debt. During that time, we’ll have volatility.”

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