By Nick Evans
If the first few weeks of the year are anything to go by, 2011 is going to be anything other than plain sailing for managers and investors.
Those expecting a benign start to the year had a nasty wake-up call in January. European equity markets saw massive sector rotation. And emerging markets suffered a sudden outbreak of volatility on the back of unrest in north Africa and rising inflation worries in the major emerging economies like China and Brazil.
Market benchmarks overall did not move all that much on the month, which made it an even worse start to the year for the many long/short equity managers that kicked off the year with a painful and somewhat surprising loss.
But the level of individual stock volatility was intense. And the events of January have further highlighted the overriding challenge for managers in this current febrile market environment of getting both the macro and the micro view right and the ever-gathering cloud of tail risks that have the potential to blow almost any type of strategy off course.
Wherever you look there are causes for concern at a big-picture level: repeated rate rises in China; global inflationary (and deflationary) pressures; food and commodity price escalation; currency wars; still-rumbling sovereign debt crises in Europe and the G10; fast-growing cracks in the US municipal bond market; social unrest in the Arab world and other emerging markets; and, most of all, the effects as and when interest rates start to tighten again.
On top of all these are very deep-seated anxieties about the impact of QE and economic stimulus programmes in several major economies (and, conversely, austerity programmes in several others) and the likely timing and consequences of their eventual withdrawal and a gnawing sense of unease that the deleveraging that is so badly required at corporate, financial and sovereign levels has not even really begun.
Adding a further layer of angst and uncertainty at a very unhelpful and unwelcome time is the constant interference by politicians and regulators in the financial system whether through the AIFM directive in Europe, the Dodd-Frank Act in the US, government bank levies, bonus-bashing or general political grandstanding.
All this tinkering will probably just result in a raft of ill-thought-through new banking regulations the only sure outcome of which, at some future point, will be a whole new series of unintended and probably disastrous consequences, just as happened the last time around.
And it will also almost certainly act as a significant brake on the economic growth and recovery that is so urgently required to get out of this mess, by shackling the financial system at a time when its vibrancy is most needed.
Set against this rather less than rosy backdrop, though, are three fundamentally very bullish drivers. One is the fact that so many companies seem to be in very healthy and increasingly optimistic shape.
Another is the continuing wave of liquidity into risk assets as investors, sick of holding cash in an inflationary and zero-rate environment, capitulate into owning equities and corporate bonds in a desperate hunt for yield and returns.
And third is the growing evidence of economic recovery in the US and elsewhere, although it would be disappointing if all the government injections were not stimulating some kind of recovery.
So, all in all, it is not exactly an easy environment in which to be managing money and one in which the upside and the downside risks are equally strong. But that is what hedge fund managers get paid to do and that is why the best ones are worth every penny.
Protecting investors capital and generating good risk-adjusted returns are not easy things to achieve at the best of times not least since hedge fund investors have a habit of wanting to participate in the upside, but not in the downside.
In this kind of climate, they are exceptionally difficult and, in a period when conflicting headwinds and tailwinds are swirling around with such speed and severity, all the more so.
As our EuroHedge Awards 2010 report in this issue shows, there are many individual funds and firms that achieved these aims with impressive results last year which was not an easy year either and who have shown remarkable consistency over the years.
It will be fascinating and revealing to see who succeeds in doing this again in what already looks certain to be another very challenging year and how they succeed in doing so. But
those who get it right will certainly have earned their fees many times over.