Trends Watch: November 8, 2018
EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.
This week, Elana talks with Nicolas De Vial, CIO, Fontainebleau Capital.
What is your outlook for hedge funds?
Hedge funds in general have had a difficult time over the last couple of years in a world where financial market volatility has been repressed by all central banks. They also have had to compete with the rise of passive investment products like exchange traded funds which offer much lower fees. In this environment, many funds have either shut down or reduced their fees.
We see two reasons why the hedge fund industry future might get brighter, however. First, after 10 years of interfering with financial markets, central banks seem finally willing to normalize their policies which means active market participants will regain a larger role in the markets. Secondly, the classic benchmarks like the S&P500 should be easier to beat over the next decade both in terms of absolute performance and volatility adjusted ratios. The current bull market being already 10 years of age, it is hard to believe equity markets will remain as smooth for another decade.
What is your outlook for the economy?
The world has never been a safer and more integrated place and we see this trend accelerating despite potential setbacks due to populist policies. Machine learning, biotechnology and blockchain technology will change the world in the coming decades, making it an ever safer, more rational and business-friendly place. We will live longer, healthier and have ever more leisure time. While this sets the stage for long-term positive prospects, in the short run, financial markets and the economy will have to transition through a much more volatile period because central banks are taking a step back. We suspect the U.S. economy will keep growing in the years ahead but this doesn't mean financial assets will not experience much more volatility as their rates of return have far exceeded the GDP growth rates over the last few years.
What keeps you up at night?
The real elephant in the room is the long-term prospects for interest rates and inflation. Central banks have used and possibly abused policy tools to prevent much short-term pain for many industries which has two negative consequences in the long run.
First, an artificially low interest rate environment for economic agents inevitably means business decisions have not been optimal for long-term growth prospects. For example in the U.S., much of the rising corporate debt has been used to solely increase leverage with stock buybacks. Another example is the case of large European banks and even countries that have been allowed to survive the last great recession without having cleaned out their balance sheets.
Second, by monetizing the deficits, central banks have left the door opened for very tempting populist policies. We already see a steep rise of the deficit in the U.S. at a time of strong GDP growth. Similar fiscal expansions will inevitably be too tempting to resist around the rest of the world. Eventually, we could see central banks losing control of the long end of the yield curve in a rising inflation environment. This could set the stage for a much deeper crisis than the great recession of 2008.