With interest rates rising and stock prices falling, 2019 is setting up to be one of the most challenging environments investors have faced in some time.
To get a sense of what some high-profile investors are thinking for the year ahead, The Wall Street Journal interviewed several hedge-fund managers with some of the most consistent long-term performances.
The managers have a variety of ideas, from being bullish on commodities and Turkish banks, to shorting U.S. leveraged loans and U.K. gilts. Their fears included rising global trade tensions, geopolitical risks surrounding the European Union and the euro, and a potential slide in investor confidence. Other hedge-fund managers say they fear the unrecognized costs of climate change. Here are four of the managers’ outlooks.
Natural Gas, Oil and Gold (buy)
Nigol Koulajian —AlphaQuest
Strategy: Systematic macro
Assets: $1.7 billion
Launch Date: 1999
Annualized Net Returns: 11%
Nigol Koulajian runs a purely systematic shop, an industry term meaning he uses various proprietary programs that identify when the character of an asset’s price movement is changing. Often, when prices are bouncing all over the place, that can indicate when a high is being formed, or now, as in the case of natural gas, crude oil and gold, when a rebound appears to be set to take off. That’s what Mr. Koulajian’s programs say is now happening.
“We are currently seeing an unwinding of short positions on natural-gas contracts which had been built up by hedge funds and other institutional investors,” Mr. Koulajian says. “Price volatility is revealing larger swings on the upside and smaller movement on the downside, suggesting a bottom is forming on natural-gas prices and rising prices likely in 2019.”
To Mr. Koulajian, this also indicates oil prices will soon stop falling and start rising. He expects gold prices will start moving upward, too.
The biggest risk he sees in the coming year: stagflation, where inflation and interest rates rise while GDP growth slows.
Leveraged loans (sell)
Hanif Mamdani —PH&N Absolute Return
Assets: $1.3 billion
Launch date: 2002
Annualized Net Returns: 13.5%
With the credit market having peaked and a bear market likely under way, Canadian hedge-fund manager Hanif Mamdani says a key area of concern to him is the market for leveraged loans—senior loans made to largely below-investment-grade borrowers.
The leveraged-loan market is now the second-largest corporate debt class in the U.S., behind investment grade, standing at $1.3 trillion. Exceeding high-yield debt issuance, leveraged loans have become the go-to market for highly indebted firms, says Mr. Mamdani.
Insatiable investor demand for high-coupon, floating-rate debt, fueled by how well leveraged loans held up during the financial crisis, has led to the doubling in size of these loans over the past six years. Mr. Mamdani figures that upward of 80% of these loans are issued based on optimistic projections, excessive leverage, and with minimal covenants. With interest rates rising and global growth ebbing, he expects these loans could sell off by 10% or more over the next 18 months.
A simple way that individual investors can play this thesis is by shorting—betting against Invesco Senior Loan ETF (BKLN), an exchange-traded fund that tracks leveraged loans. Because such a short requires payment of the 5% interest yield that the ETF spins off, Mr. Mamdani recommends partially covering that liability by simultaneously being long one-year Treasury bills. He projects net return in 2019 on this defensive hedge to be from 5 and 7%.
Turkish Banks (buy)
Carl Tohme—Jabcap EMEA
Strategy: Emerging markets
Assets: $270 million
Launch Date: 2010
Annualized Net Returns: 9.96%
With emerging-markets valuations bouncing around like a pinball for years, Carl Tohme may have the toughest job of all our managers.
“We have been negative on Turkey since the beginning of 2018,” says Mr. Tohme. “But we believe rate increases by the Central Bank of Turkey, which has doubled its benchmark rates to 24% in September, are beginning to address some of the country’s financial challenges.” This has helped the Turkish lira to rally back more than halfway from its 40% decline against the greenback in 2018.
Although he doesn’t expect to see a V-shaped recovery, Mr. Tohme thinks the Turkish economy and market are on the mend, especially if energy prices stabilize and the Federal Reserve eases up on interest-rate increases.
Because he believes Turkish banks will be recapitalized by the end of the first quarter of 2019, Mr. Tohme considers them to be trading cheap, below 0.5 times book value and around 3.5 times forward earnings, which prices in a projected recession in 2019.
(the latter majority-owned by the Spanish bank
). “These are well-regulated, conservatively managed, private institutions,” says Mr. Tohme, “with solid capital and liquidity ratios, which should help them weather the recession and thrive in the subsequent recovery.”
Mounting trade tensions worry Mr. Tohme, especially if they continue to fuel volatility across all markets. But if China and the U.S. begin to work out their differences, and if the U.S. holds off on further rate increases, Mr. Tohme thinks emerging-markets shares and their underlying currencies should outperform developed markets in 2019.
Bob Treue —Barnegat
Strategy: Fixed-income relative value
Assets: $661 million
Launch Date: 2001
Annualized Net Returns: 15.9%
Relative-value trades are where managers look for financial instruments that should trade in lockstep with one another but whose values have deviated. Managers bet these spreads will close.
“Government bond yields should be higher than inflation,” says Bob Treue. “But at the end of the year, the 30-year British gilt yielded 1.95% while an equivalently termed U.K. inflation swap was at 3.30%.”
While the Bank of England’s unwinding of quantitative easing should help boost yields on long-term U.K. government bonds, Mr. Treue says it isn’t clear when this correction will occur. But he says the market will make it happen.
Mr. Treue is short the long-term gilt, believing its yield will rise and price will fall, and he is long inflation swaps, believing the inverse will happen. He has structured the trade as to currently earn money as he waits. The carry costs of the trade can be offset by the yield that part of the transaction generates. Because the inflation swaps are so mispriced, compared with the gilts, the yield currently exceeds costs.
The manager sees significant dislocation from quantitative tightening that’s now under way in the U.S., creating mispricing in the debt market. What he fears most is a rapid meltdown in market confidence as global trade tensions and deglobalization produces a “free-for-all” mentality.
Mr. Uhlfelder writes about global capital markets from New York. He can be reached at firstname.lastname@example.org.