A global depression caused by a trade war. An overhaul of health care. Rising inflation and deregulation.
To find out what hedge fund managers are looking out for in 2017, we asked several who topped Bloomberg's 2016 global ranking of the 50 best-performing hedge funds with more than $1-billion (U.S.) in assets. After riding a jump in equities, oil and high-yield debt in the past year, some of the managers see more opportunity in commodities, energy and corporate debt.
"You're going to have to take way more risk today in order to try to make outsize gains versus a year ago," said Hanif Mamdani, who runs the PH&N Absolute Return Fund at the Royal Bank of Canada. "You try to eke out a 6, 7, 8 per cent return and wait for an eventual dislocation -- whether it's because of the Fed, or a tweet."
Here are some of the bets for this year by top-ranked managers, whose firms focus on three different strategies:
Hedge funds specializing in distressed assets saw their energy-related investments soar along with oil prices last year. Even so, managers see the potential for more profits in the sector this year, particularly in equities.
Jason Mudrick manages the Mudrick Distressed Opportunity Fund, which led the ranking with a 38.7-per-cent gain.
"There is still an opportunity in commodity-related credits due to the discrepancy between private distressed credit-market valuations and public equity-market valuations," Mr. Mudrick said in a Jan. 19 letter to investors. "This valuation discrepancy dissipates as these companies convert debt to equity and move past their restructurings." He's also analyzing distressed opportunities in retail, health care, media and technology.
Bill Raine co-manages the Contrarian Capital Fund I, which placed eighth.
"There are a number of companies that have restructured that have potential for strong returns in the equity," Mr. Raine said of energy companies in an interview. "Now that they have stronger balance sheets, they'll start drilling again, and some are drilling in very, very attractive basins."
His firm has also been studying hospitals and pharmaceutical companies that would be affected by sweeping changes to the Affordable Care Act. "We're reasonably sure there will be winners and losers, not just the hospitals but a lot of parts of health care that have probably benefited from this uptick in insured population," he said.
Another source of turmoil would be a border adjustment tax, which targets imports and would hit retailers and oil refiners that process imported crude, he said.
Eric Scheyer co-manages Magnetar Capital's MTP Energy Fund, which gained 22.8 per cent, taking the 13th spot.
"Energy companies are generally in growth mode with commodity prices coming back up into a range where they can get reasonable rates of return," Mr. Scheyer said in an interview. "We expect to see a lot of M&A and more corporate activity overall, and this presents a great opportunity set for investors with flexible strategies."
The firm sees selective opportunity in energy service company stocks, which may benefit from increased upstream, or exploration and production, activity, he said. It also likes Canadian upstream companies, which have been negatively impacted by concerns about a potential border tax.
Some multi-strategy managers, who invest across asset classes, expect rising inflation and higher interest rates to make corporate debt and asset-backed securities more attractive.
Mr. Mamdani's PH&N Absolute Return fund rose 33.5 per cent, grabbing the No. 2 spot.
"With oil stabilizing there's an opportunity if you dig into some of these energy stocks because they were all moving in tandem," he said. "Some are probably too rich because they've just traded up with oil, and some have lagged and are too cheap."
He also likes short-duration callable bonds that could be bought back by their issuer within the next year as a "defensive trade."
Michael Hintze runs the CQS Directional Opportunities Fund, which ranked fourth.
Within the bond market, corporate debt "should benefit from fiscal stimulus and default rates, while likely to rise, should remain relatively low, especially if we have some inflation which would be positive," Mr. Hintze wrote in a December letter to investors.
Rising interest rates in the U.S. are drawing Mr. Hintze to convertible bonds, loans, asset-backed securities and high-yield debt. Convertible notes "perform well during inflationary periods due to their equity optionality," he said, while mortgage-backed securities "should benefit from accelerated pre-payments as rates rise."
Managers who specialize in stock-picking may see opportunity as U.S. President Donald Trump seeks to deregulate a number of industries, lower taxes and repatriate overseas cash, which could fuel more share buybacks, capital expenditures and takeovers.
Robert Bishop manages the Impala Master Fund, which finished ninth.
Mr. Bishop, whose fund surged off of commodities-related equities bets last year, remains confident the sector will continue to benefit as China ramps up overseas investments. It aims to revive trade across Central Asia and into Europe via a network of railways, ports and highways. The sector is also set to benefit from fiscal stimulus across Western economies, particularly the U.S., he said in a Jan. 31 investor letter.
"These factors should lead to a better environment for commodity prices and their related equities. Equipment and parts suppliers for these industries should also benefit," wrote Mr. Bishop.
Richard Maraviglia and Matt Barkoff co-manage Carlson Capital's Black Diamond Thematic Fund, which gained 19 per cent, ranking 21st.
The managers are taking an opposing view to Bishop, as they see "a variety of factors that could cause macro deceleration just at the moment when investors have been dragged kicking and screaming into cyclical positioning," they said in a fourth-quarter letter. A border adjustment tax would "cause a global depression and a major equity market decline," they wrote.
"When this becomes apparent commodities will correct meaningfully and we will reinvest in inflation beneficiaries," they said. "Until then we are short cyclicality with what we assess to be tremendous risk-reward optionality through semiconductors, industrials and miners."