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2025 began with general consensus on the relative strength of the US economy, but in the wake of “Liberation Day”, market expectations have quickly shifted and investors are now anticipating a recession in the US. In the absence of a major pull back on tariffs, uncertainty may lead to lower economic activity: corporate investments, M&A and IPOs will be at best delayed until deals are struck and the ability to pass-through tariffs is tested. Meanwhile, recent surveys suggest US consumers are increasingly worried about rising inflation and job security. With inflation expectations still elevated, the Fed will have to wait for more evidence of demand destruction and / or rising unemployment before substantially lowering rates. On the other end, Europe and Asia may have to absorb excess supply, potentially leading to deflation and lower interest rates—which, when combined with renewed fiscal stimulus, could offset tariff headwinds. Yet, with the US entering a potential economic downturn, negative impacts on the global economy will be inevitable.

Trading

Although asset prices have yet to discount a global recession, Equity Hedged managers have generally reduced their net exposure toward historical lows, while most discretionary macro managers have added to their long positions in the front-end of US rates. This has organically created a more defensive posturing in our portfolios. Despite a difficult April, we continue to see plenty of opportunities in Trading across asset classes and regions, reflected by increasing performance dispersion across the peer group. We believe the repricing of US (political) risk premia can be best expressed by trading the US yield curve, cross currency rates, and FX. As such, we have marginally increased our allocation to the strategy for Q2. We also continue to be excited about opportunities in energy commodities, especially in gas and power trading.

Equity Hedged

As the outlook for equities continues to be challenged by trade policy, our core Equity Hedged managers have prudently reduced risk, especially in areas such as consumer and industrials. As it often occurs in a “micro to macro” regime shift (e.g., Covid), fundamental stock pickers will need to recalibrate their research to understand first and second order effects. Once the dust has settled, we expect more differentiation between the best and worst performing companies, leading to rewarding alpha themes. We also continue to believe that the net effect of Trump’s policies (e.g., tax cuts and deregulation) will eventually be beneficial to the US economy, while interest rates could be materially lower later in 2025. As such, we are optimistic that a more benign environment for Equity Hedged could manifest in the second half of the year. Looking ahead, we expect to maintain our fundamental equity allocations given that any impulse to redeem would not be effective until July, anyway. That said, we plan to rebalance the geographical exposure in favor of European long / short. Approximately 20% of US equities are now held by foreign investors, with almost half being European; this level has been slowly increasing year-on-year but could reverse as “US exceptionalism” is re-evaluated. In our view, factors including political and geopolitical currents, a potential fiscal renaissance in the EU, and attractive relative valuations could sustain a rotation into European equities in the medium term and broaden the opportunity set.

Relative Value

We are not making any other change in Relative Value strategies; however, we are starting to be more constructive about returns in fixed income relative value (FIRV), where persistent volatility and some degree of deleveraging may lead to more attractive returns in the future.

We believe the resilience demonstrated by quantitative strategies during the recent alpha drawdown is a testament to its ability to offer a differentiated alpha profile compared to fundamental equity long / short strategies, and we will look to add exposure selectively. We maintain a strong bias for market-, beta-, and factor-neutral strategies which can better weather regime changes and factor-oriented reversals.

Since last quarter, the uncertainty over trade policy and the economic environment has increased, causing a material decline in corporate confidence and a freeze in capex; as such, we are downgrading our outlook for merger arbitrage strategies to negative.

Credit / Income

With a potential US recession looming, credit and liquidity risk premia have been rising. Therefore, we believe it is prudent to begin raising cash from fundamentally oriented asset-backed and structured credit strategies. The capital can potentially be redeployed into opportunistic investments in corporate credit should spreads continue to widen.

Similarly, we are preemptively reducing allocations to agency MBS strategies. After a few years of record-low transaction volumes for secondary homes, a major restart from lower mortgage rates could provide a much-needed boost to economic growth, along with an unprecedented wave of refinancing.

Index descriptions

The use of indices is for illustrative purposes only.