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What investment instruments are in demand among fund managers in 2021?

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2021 has been a frothy year for the securities markets. The S&P 500 is up 27% year-to-date, the  Nasdaq Composite up 27%, and the NYSE Composite also up 27%. It’s a continuation of a bullish market that sent securities soaring in 2020 despite a health crisis that greatly affected the economy.

Hedge funds are major players in any securities markets, be they bearish or bullish. It’s been the same this year and even better as many funds have gotten big gains and turned around to push those gains back into the markets. As of this June, total hedge fund assets stood at $4 trillion, a record amount.

So, what investment instruments are the hedge fund managers largely buying as part of their shopping spree in 2021?

They include stocks, bonds, equity swaps, loans, distressed assets, and the likes. Let’s expand more on that.

  • Stocks

Stocks have been greatly in demand by fund managers this year, expectedly as they have soared across the board. Indexes such as the Nasdaq and S&P 500 have hit record highs this year, driven in part by hedge fund activity. With their record gains both from soaring stocks and investment inflows, it should be no surprise that hedge funds are betting more on stocks this year.

They’re different styles adopted by hedge funds betting on stocks. Some buy shares of a company they believe have good long-term or short-term prospects, e.g. Bill Ackman and Domino’s, while others such as quant hedge funds buy and sell large blocks of shares daily, not out of conviction but rather daily fluctuations that they take advantage of to make profits.

  • High-Yield Bonds

The bond market has been on fire this year, driven in part by hedge funds. For example, a record $140 billion of high-yield bonds were sold by US companies in the first quarter of this year. As of July, that number had gone up to nearly $300 billion, up 51% compared to the same period in 2020.

Hedge funds are among the biggest bond buyers on the markets and they’ve continued that streak by buying bonds at record rates this year.

  • Mortgage-backed securities

The mortgage market has raged all the way this year and the last. 2020 was unprecedented, where a record $4.3 trillion of mortgage loans were issued, and 2021 has continued the streak of a raging mortgage market though lower than the previous year.

Because of the frothy mortgage markets, the issuance of new mortgage-backed securities, i.e. bonds secured by home and real estate loans, is at heightened levels. Hedge funds are major buyers of mortgage-backed securities and are buying them at record rates this year.

  • Commodities

This one is a unique case, because generally hedge funds were shying away from trading commodities over the years. However, in 2021, hedge funds have begun investing more in commodities, with inflows into the sector eclipsing outflows, likely because the industry is flush with cash as never before.

Common commodities traded by hedge funds include oil, silver, gold, and copper. You need to establish strong connections in those industries to buy them, as there’s professional ready-made software where it’s organized, e.g. MetaTrader 5 for hedge funds.

  • Cryptocurrencies

This one sounds out of the norm and rightly so, but hedge funds are increasingly dabbling in cryptocurrency trading in 2021. Over the past few years, there has been a rise in the number of hedge funds dedicated to trading various cryptocurrencies, most especially Bitcoin. Examples of major crypto hedge funds include Pantera Capital, Coin Capital, and Nickel Digital.

Because this year has been favorable to the crypto markets, hedge funds focused on the area have performed very well, with their assets up 145% compared to 2020. However, cryptocurrencies are very volatile and subject to swings of highs or lows at any given period. Because of this volatility, many hedge funds have stayed away from it, making crypto still a niche in the industry.

  • Exchange-traded funds (ETFs)

Global exchange-traded funds (ETFs) have attracted record investments this year, driven in part by hedge fund activity. As of July, nearly $500 billion of fresh capital had flown into ETFs from Wall Street firms, including many hedge funds, and that number is almost on par with the $497 billion record set in 2020. It implies that even though 2020 was a record-breaking year for ETFs, 2021 is even better, with inflows in the first six months nearly topping that of the whole previous year.

Hedge funds relish trading ETFs and they have with no doubt contributed to the record inflows into the sector this year. Something unique in the markets this year is the rise of ETFs with a focus on Environmental, Social, and Corporate Governance (ESG). Many new ETFs this year have been ESG funds, responding to the increasing demand for fund managers to pair their investing with social responsibilities across the board.

  • Derivatives

Hedge funds are experts at trading derivatives, which are financial contracts deriving their value from an underlying asset, e.g. stocks, loans, or even physical goods like oil and farm produce. Common types of derivatives include futures, options, and equity swaps.

Derivatives trading is the turf of hedge funds and they’ve maintained that turf this year, expectedly. In fact, any uptick in trading the types of assets listed above correlates with an uptick in trading derivatives based on them. According to Bloomberg, there’s been a trend this year of derivatives replacing bonds as the new hedge for many hedge funds.

  • Currencies

Hedge funds are buying and selling a whole lot of national currencies in 2021 just like with the previous years. It’s what’s known as foreign exchange, or short form “forex”.

A well-known forex strategy used by hedge funds is borrowing funds in a currency with low-interest rates and using it to buy other currencies with higher rates, referred to as “carry trades”. Many hedge funds are using dollars to buy currencies in emerging markets with higher yields, e.g. South African rand and Colombian pesos, and profiting off it, but however, this strategy carries significant risk.

In all, hedge funds are flush with cash and continuing their usual trading activities in 2021, but there are some notable trends such as the increasing congregation towards ETFs and cryptocurrencies.

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