The most sought-after hedge fund strategy

The US housing imbalance. # # --------------------------------------------------------------- The key takeaways today: - Investors are seeking hedge funds with credit strategies - The shifting supply chains between Korea, Taiwan, China, and the US - When will the Federal Reserve announce its first rate cut? - Demand is still outstripping supply in the US housing market - Briefings Brainteaser: Which currency has rallied most against the US dollar this year? Was this newsletter forwarded to you? [Sign up now](. --------------------------------------------------------------- Hedge funds investing in credit are in demand Asset allocators are, for a second year in a row, [more interested in hedge funds that invest in credit]( than in any other strategy. The demand for credit hedge fund strategies (which include the trading of assets like company debt, structured credit, and some sovereign instruments) comes after both bonds and stocks rallied last year, according to the Goldman Sachs Prime Services Hedge Funds Insights and Analytics team's 2024 Hedge Fund Industry Outlook. Capital allocators reported an average gain of 6.4% from their hedge fund portfolios between January and November 2023, up from a 0.9% loss in the same period in 2022. The report includes a survey of responses from 358 allocator firms globally, who control more than $1 trillion of assets allocated to hedge funds, as well as responses from 302 hedge fund managers who are clients of Goldman Sachs' Prime Services business and collectively manage more than $1 trillion. - Some 44% of investors plan to increase their exposure to hedge funds with a credit strategy this year and only 3% plan to decrease it. As in the previous report, distressed company credit and long-short credit (a strategy of betting on appreciation as well as depreciation, often including hedging) were the most sought-after sub-strategies for hedge funds. - Demand for Asia-focused hedge funds peaked in 2021, with almost half of allocators surveyed expressing interest in increasing their exposure to the region. Now it's the least sought-after, falling behind Europe and North America. Interest has increased slightly for Japan and pan-Asia strategies at the expense of demand for China, which continues to decline. - Despite positive returns (on average) in 2023, hedge funds underperformed traditional 60/40 portfolios (which allocate 60% of funds to S&P 500 stocks and 40% to 10-year US Treasury bonds) by the widest margin in since 2000. Hedge funds came into the year defensively positioned and struggled to keep pace. For more on the outlook for hedge funds, listen to [the Markets podcast](. --------------------------------------------------------------- Supply chains are shifting between China, Korea, Taiwan, and the US Asia's supply chains are shifting. In December 2023, combined exports from Korea and Taiwan to the US exceeded their exports to mainland China for the first time in two decades, according to Goldman Sachs Research. The changes are taking place amid several important shifts. China's unit labor costs have risen (from 30% of US levels in 2000, based on purchasing power, to nearly 70% in 2019), and its industrial structure is becoming more sophisticated. As China moves up the value chain and drives for greater self-sufficiency, it has reduced imports of intermediate goods (notably chemicals, automobile parts, and electronic components) while increasing its imports of final consumer goods. China's supply chains for the electronics industry are potentially vulnerable to these changes. Some tech imports into China are still used mostly for re-export — for instance, 57% of China's microchip imports in 2023 were re-exported. The large portion of imports for re-export in the electronics industry means that relocation of factories assembling technologies such as smartphones from China to elsewhere in the region could redirect both imports and exports of tech products away from China. Companies' post-pandemic focus on supply chain diversification and the US's supply chain resilience programs are also reshaping trade in the region. Supply chains around advanced microchips have been shifting away from China since the pandemic outbreak in early 2020. Notably, changes in trade flows for smartphones have accelerated since the pandemic with rapid declines in imports of made-in-China smartphones in the US and Europe. (Admittedly, smartphones made in other countries might still use key components from Chinese factories.) Moreover, [accelerating innovation in AI]( and the US drive for supply chain resilience have boosted US demand for AI chips. All these developments have led to sharp increases in US-bound exports from Korea and Taiwan of AI servers and their advanced chip components. --------------------------------------------------------------- A midsummer expectation for the Fed's first rate cut The Federal Reserve will likely begin cutting interest rates when inflation is still modestly above the 2% target, [according to the Wealth Management Investment Strategy Group (ISG)](. The Fed chair Jerome Powell indicated as much in a press conference following the central bank's policy meeting in December. “You wouldn't wait to get to 2% to cut rates, [as that] would be too late,” Powell said. “You'd want to be reducing restriction on the economy well before 2%.” The Fed's estimate of the nominal neutral rate is 2.5%, and with the target range currently at 5.25-5.5%, the policymakers believe there's plenty of room for cuts while maintaining an overall restrictive stance. That said, the Fed also declared, at its January meeting, that it “does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%.” More recently, Fed commentary suggests that a rate cut in May would probably be too soon. For this reason, combined with hotter-than-expected January inflation data, ISG has pushed back its expectation for the timing of the first rate cut from March to June, even as ISG continues to expect four 25-basis-point cuts this year. --------------------------------------------------------------- High mortgage rates, limited inventory continue to challenge the US housing market High mortgage rates and limited inventory have created one of the tightest US housing markets in decades. While mortgage rates are likely to ease somewhat if the Federal Reserve cuts rates later this year, as is widely expected, the supply of available homes still needs to catch up to demand, according to Goldman Sachs Research's Roger Ashworth. Average mortgage rates, currently at 7%, would need to fall closer to the average outstanding loan rate of about 3.8% to incentivize current homeowners to move, [says Ashworth on Goldman Sachs Exchanges](. “If I go buy a house down the street, it's going to cost significantly more at a much higher mortgage rate. Around 97% of the mortgage market right now is out of the money to refinance their loan and likely not thinking about moving anytime soon.” Roger Ashworth (L) and Allison Nathan of Goldman Sachs Research Homebuilders are working through supply chain delays and labor shortages, which have constrained the inventory of new homes in the market since the pandemic, Ashworth says. That limited supply is another reason that home prices [are expected to appreciate by about 5%]( this year. The lack of buyers for mortgage bonds is another critical factor keeping mortgage rates high, he says. Once interest rates start to fall, more banks are likely to step back in as buyers; Ashworth expects mortgage rates to fall to about 6.3% by the end of this year and to 6% by the end of 2025. --------------------------------------------------------------- Briefings Brainteaser: Special FX Interest rates are widely expected to decline in many major economies this year. And changes in monetary policy are, in turn, filtering though the foreign-exchange market. Which of these currencies has been the most resilient against the US dollar this year (as of March 13)? A) Euro B) Australian dollar C) Swiss franc D) British pound [Check the answer here](. --------------------------------------------------------------- Goldman Sachs in the news By clicking on these links, you will redirected to external websites that Goldman Sachs does not own or operate. Goldman Sachs is not responsible for the products, services, or content provided on those sites. Please refer to each external website's terms, privacy and security policies for details. [CNBC]( March 8 Fed will cut rates four times this year, says Goldman Sachs' Jan Hatzius (3:40) --------------------------------------------------------------- --------------------------------------------------------------- Some of the images used in this newsletter are sourced via Getty Images. The opinions and views expressed in this newsletter may not necessarily reflect the institutional views of Goldman Sachs or its affiliates. The information provided in this newsletter is for informational purposes only and does not constitute a recommendation from any Goldman Sachs entity to the recipient. Goldman Sachs is not providing any financial, economic, legal, investment, accounting, or tax advice through this newsletter or to its recipient. Certain information contained in this program constitutes “forward-looking statements,” and there is no guarantee that these results will be achieved. 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