The quiet resurgence of hedge funds

Investors are contending with an increasingly complicated environment. A global energy shock and unsettled tariff arrangements are amplifying geopolitical volatility, AI advancements may prove disruptive to business models across industries, and central banks are increasingly pursuing different monetary policy paths amid a multi-speed global economy.

Coupled with the relatively recent decline in the diversification benefit of combining stocks and bonds, we believe select hedge fund strategies may deserve a more prominent role in portfolios. Specifically, we believe absolute return strategies that pursue positive performance across a wide range of market environments may improve a portfolio’s overall risk and return characteristics, contributing to more effective growth over time.

We’re not alone in this assessment. Hedge funds are quietly moving back into focus: the industry reached a record $5.1 trillion in assets in the fourth quarter of 2025, following nine consecutive quarters of growth, while net inflows reached $116 billion in 2025—the strongest annual total since 2007.¹

Flexibility enables many hedge funds to perform in challenging environments

Hedge funds are often able to calibrate risk through challenging periods with greater precision than other asset classes. For example, hedge funds nimbly increased their hedges, or short positions—which increase in value when investments decline—during late February and March 2026 as markets tumbled in response to the Iran conflict and energy shock.

Performance numbers show why this flexibility to reposition quickly can be beneficial in volatile periods: during the first quarter of 2026, hedge funds as a group returned 0.7% compared to bonds at 0.0% and U.S. stocks at -4.6%.²

Across different types of hedge funds, first-quarter 2026 average performance ranged from approximately -0.5% in strategies that seek to offer hedged exposure to equities up to about 4.5% in global macro strategies that position across asset classes and regions based on broad economic and policy trends.³

Together, we think this depicts the much more palatable performance tilt that we expect from hedge funds during periods of market stress compared to what traditional stocks and bonds have been able to provide.

Fragmentation creates opportunities

Many of the same points of increasing complexity that investors are confronting—from geopolitical strains, central bank policies, industry disruption and changing asset class relationships—represent opportunities for hedge fund strategies.

• Global macro strategies can capitalize as central bank policies evolve along with the inflation  outlook and turbulence in energy markets.
• Event-driven strategies can position around increasing corporate merger and acquisition activity amid higher boardroom confidence.
• Hedged equity strategies are designed to parse company-specific details, making them well-suited to succeed as company-level outcomes become less synchronized in a world divided along the lines of “AI winners and losers.”

Hedge fund managers are beginning to find opportunities in software and other industries hit by AI disruption, where “baby with the bathwater” companies may have been sold indiscriminately by fearful investors. The pessimism inherent in lower prices can offer more attractive entry points, ultimately creating better opportunities for managers with the sophistication to understand these companies and the forces acting upon them.

Manager selection makes a major difference in outcomes

The average difference between the best and worst performing hedge fund managers ranged by almost 15% annualized over the 10-year period ending in the fourth quarter of 2025.⁴ We believe this shows why selecting the right managers—and avoiding the wrong ones—is crucial to investment outcomes.

The difference between a disciplined hedge fund manager and an overextended one can become visible very quickly. We scrutinize hedge funds on their use of leverage, appetite for risk, and tools in the toolkit for managing through market drawdowns.

The same forces that unsettle markets can create openings for managers with patience, flexibility and strong underwriting discipline. Elevated valuations, performance concentration within a small group of stocks, and less reliable diversification in traditional asset classes all strengthen the argument for select exposure to hedge funds, in our view. But their value depends heavily on identifying managers with sufficient skill, risk discipline, liquidity management and the ability to adapt as conditions change.