What Lies Beneath

Given the moves on the last trading day of the month, it would be remiss to start a review of January anywhere but precious metals. Gold dropped nearly 10% and silver fell a whopping 27% on 30 January.

Both markets had been hitting daily record highs and attracting increasing retail speculation (alongside more established trend-following institutional managers). But it speaks to just how volatile these assets have become that silver still finished January up over 18% year-to-date, even after the last-day capitulation.

It is futile to try to fit a fundamental narrative to these moves. Not that this stops various commentators painting the current price of both metals as somehow a rational response to an uncertain world and the risks of inflation.

Conveniently, we have assets such as Treasury Inflation-Protected Securities (TIPS) that reflect expectations of future inflation more precisely. While breakeven inflation rates have crept higher this year (the five-year rate moving from around 2.15% to 2.55%), these moves are well within the bounds seen over recent years.

Liquidating assets

The most damning indictment of the precious metals boom is Bitcoin's simultaneous 7% drop on the last day of the month. It is hard for us to draw any other conclusion: retail investors were liquidating all assets with little fundamental rationale as losses mounted.

Amid the meltdown in precious metals, US President Donald Trump finally announced his choice for the next Federal Reserve (Fed) chair: former Fed governor Kevin Warsh. The broad consensus is that Warsh is a relatively safe choice for markets. Markets were pricing in 1.8 interest rate cuts by January 2027 before the announcement and 1.9 after, well within the typical range of daily moves.

His appointment is likely to shift the Fed towards a more strategic, forward-looking stance than its current data-driven tactical approach. This may leave more room for the central bank to show its hand on themes such as the impact of AI on employment and productivity. On the question of Fed independence, several respected commentators are confident Warsh will stand up to Trump should their views materially diverge.

Erratic equity market factors

Another significant story for hedge fund managers was the continued erratic behaviour of equity market factors. The first two weeks of the year again saw strong gains from heavily shorted stocks (the Goldman Sachs Most Shorted Index rose 18.3% through 16 January), alongside robust performance from factors such as Beta, Momentum and Volatility.

Usually, when high-beta and highly volatile stocks outperform their peers, so do growth-driven parts of the market. But through the first half of January, the leading sectors in the S&P 500 were Industrials, Materials, Energy and Consumer Staples. Hardly a hotbed of irrational exuberance.

This disconnect between factors and sectors left some quantitative equity market-neutral strategies nursing losses early in the year. The second half of January saw something of a reversal, with Value and Quality stocks outperforming.

Narrow narratives

The discrepancy between headline index volatility (still subdued regardless of geopolitical flare-ups) and factor volatility (which remains very elevated) is likely driven by the narrowness of market narratives. Higher gross exposures at market-neutral hedge funds are probably exacerbating this, leading to crowding in similar stocks.

This phenomenon may be amplifying market rotations in reaction to geopolitical and other events. With such frequent pockets of volatility across markets (from commodities to foreign exchange to equity factors), one would be forgiven for looking at 2026 with a degree of trepidation. As usual, our response is to avoid directional, overconfident positions and remain liquid and nimble to capitalise on opportunities as they develop.

Key drivers of hedge funds’ performance:
an early January snapshot

Equity Long/Short:

• January was a positive month for Equity Long/Short strategies, with the HFRX Equity Hedge Index posting solid gains. Managers generally added value through both beta (market exposure) and alpha (stock selection), with the strongest returns coming from discretionary managers taking more concentrated positions
• There was a high level of single-stock dispersion during the month, with companies in previously overlooked sectors such as Materials, Industrials and Energy performing particularly well. This led to significant performance dispersion across the hedge fund universe, with some managers posting extremely strong returns while others were slightly down
• The weakest performance came from managers with a quantitative and market neutral bias, where factor volatility was again a headwind. The most shorted stocks, particularly in the US market, were the strongest performers in the first three weeks of the month, although this softened through the final week

Credit:

• Credit managers had a largely quiet January, posting small gains on average. The market backdrop was relatively benign, with spreads remaining tight in Investment Grade and tightening further in High Yield
• Managers continued to make strong gains in the convertible bond market, as ongoing single-stock volatility boosted returns from gamma trading
• Interest rate hedges generally added value as yield curves widened during the month
• Structured Credit markets remained subdued in January, with modest spread compression; most returns came from carry

Relative Value:

• January saw a modest slowdown in new deal activity in the US. Two notable transactions: Boston Scientific acquiring medical technology firm Penumbra for US$14.5 billion, and Hg and General Atlantic acquiring software firm OneStream for US$6.4 billion
• Conversely, in Europe, two large pre-announced deals led to a strong start to the year. Rio Tinto and Glencore restarted merger talks (approximately US$260 billion combined enterprise value), and Zurich Insurance raised its unsolicited bid for specialty insurer Beazley to US$10 billion
• Japan continued to see high levels of activism. Elsewhere, US intervention in Venezuela fuelled expectations of a restructuring of the country's distressed debt

Macro:

• Systematic Macro strategies, in particular trend following, had an extremely strong start to the year. Significant contributors included long metals and short US dollar positioning, as these assets extended their moves from previous months. Long equity exposure and short government bond exposure also helped, with many managers seeing positive returns across all parts of their books
• Non-trend Systematic Macro was broadly positive during the month, as carry, value and seasonality strategies aligned with favourable moves across asset classes
• One area of weakness was defensive foreign exchange strategies, where the decline of both the US dollar and the Japanese yen led to losses
• Discretionary Macro was more mixed, depending on manager positioning, but broad strategy performance appears solidly positive based on data available so far

On the radar:

• Over the very short term, we are watching the technical interplay between positioning in commodity markets, foreign exchange markets and assets such as Bitcoin, to better understand whether the very high levels of volatility seen in these three asset classes are driven by position liquidation
• Over the medium term, the key questions concern the AI sector's profitability and potential performance divergence: Nvidia and the hyperscalers versus the broader US equity market
• The longer-term focus remains on governments' ability to manage elevated debt balances in a higher-rates-for-longer world. The possibility of a fiscal shock from a major economy over the next two to three years should not be discounted, especially in the face of increasingly populist politics