Hedge Fund Strategy Outlook: Second quarter 2026

Second quarter (Q2) 2026 outlook: summary

As we move through 2026, the investment backdrop remains defined by elevated valuations, uneven macro signals, and a growing divergence between surface‑level calm and underlying market fragility. While past monetary policy easing has created favorable liquidity conditions, it has not resolved structural risks tied to concentration, leverage and geopolitical uncertainty.

In this environment, hedge funds have continued to offer differentiated value through diversification, active risk management and alpha generation. Elevated dispersion across regions, sectors and capital structures is creating opportunities for managers able to operate with flexible mandates and disciplined risk budgets. We believe the investment opportunity set increasingly favors strategies that emphasize alpha over beta, exploit episodic volatility and remain adaptable as macro narratives evolve.

1. Credit: The strategy has been facing increased investor attention due to greater economic uncertainty, along with concerns about valuations and illiquidity. Despite these challenges, spreads remain tight by historical standards, and there is significant dispersion at the issuer level which active and highly selective managers can capitalize on.
2. Long/short equity: We believe the combination of increasing intra‑market dispersion, broadening equity leadership beyond a narrow cohort of artificial intelligence (AI) beneficiaries, along with an acceleration in idiosyncratic, reform‑ or event‑driven catalysts across regions, support an attractive environment for stock selection.
3. Global macro: In our view, the environment remains broadly supportive, with elevated market volatility expanding the opportunity set. Meanwhile, geopolitical risks are adding complexity and uncertainty around inflation, growth and policy paths.

Macro themes we are discussing

As we move through 2026, we think the market environment remains constructive on the surface but increasingly fragile underneath. Liquidity has improved, volatility remains contained and risk assets continue to find support. At the same time, valuations are elevated, positioning is crowded, and sensitivity to incremental macro and geopolitical developments is rising. In our view, this combination reinforces the importance of flexibility, selectivity and active risk management.

1. Financial conditions are supporting markets, not resetting them.

Global financial conditions have transitioned into a more neutral—and in some areas tightening—phase, as of March 2026. While markets benefited earlier in the year from the residual effects of 2025’s central bank easing, recent inflation surprises and geopolitical developments have reduced the margin of policy flexibility. As a result, the longer these pressures persist, the greater the risk of valuation and risk‑premium adjustment. Markets have become increasingly reactive to marginal changes in data, geopolitical developments and policy expectations. We see this as an environment where returns remain available, but the margin for error is thin.

2. Moderate volatility coexists with rising dispersion.

Despite ongoing geopolitical tensions, headline volatility measures have remained relatively muted; however, divergence among regions, sectors and individual securities is increasingly pronounced. This reflects uneven growth trajectories, differentiated balance‑sheet quality, and concentrated positioning in a narrow set of themes. In our view, this is a favorable backdrop for active managers, but one that also carries the risk of sharp, short‑lived drawdowns when crowded trades unwind.

3. Geopolitical risk is now embedded in market structure.

Trade policy uncertainty, shifting alliances and a more transactional global order are no longer episodic shocks—they are ongoing inputs into market pricing. These forces are influencing corporate decision‑making, supply chains and capital allocation, and they increase the likelihood of discrete volatility events. We expect geopolitics to remain a source of periodic dislocation rather than sustained trends, reinforcing the value of tactical, flexible strategies.

4. Balance‑sheet quality and leverage are becoming more important.

Years of low interest rates encouraged higher leverage across both public and private markets. While easing policy provides some near‑term relief, refinancing risk, funding costs and capital‑structure discipline are becoming more visible differentiators. Markets are increasingly distinguishing between issuers supported primarily by liquidity and those supported by underlying fundamentals, contributing to wider dispersion within both credit and equity markets.

5. Implications for hedge fund strategies.

This is not a market that rewards static positioning or broad beta exposure. Instead, it favors managers who can adjust risk dynamically, avoid crowded trades, and exploit short‑duration inefficiencies as they arise. Elevated dispersion and episodic volatility create a steady flow of opportunities, but outcomes are likely to vary widely across managers and strategies.

We continue to view Q2 2026 as an environment that should reward agility over conviction and alpha over beta. Traditional asset classes may continue to grind higher, but downside risks are asymmetric. Hedge fund strategies—particularly those with flexible mandates and disciplined risk management—remain well positioned to navigate this phase of the cycle and deliver differentiated returns.
 

Q2 2026 outlook: Strategy highlights

Highlighting areas where evolving market dynamics are shaping the opportunity set across hedge fund strategies

Credit

Credit is facing significant cross-currents, exemplified by greater geopolitical and economic uncertainty, along with investor concerns about valuation levels, liquidity and a potential rise in defaults. Despite these concerns, credit spreads remain quite tight by historical standards due to significant supply of capital deployed to the asset class in recent years. Should the trend reverse, we believe credit markets have potential for significant downside from current levels. Elevated dispersion at the issuer and sector level—for example in areas such as software or commodity-sensitive sectors—provides the opportunity for active managers to capitalize on this dispersion through relative value and directional trading in both long and short positions.

Long/short equity

The intersection of a weaker yen, AI‑driven capex, shifting supply chains and governance reforms are reshaping the opportunity set in Japan. Japanese equities have benefited from a breakdown in the longstanding deflationary regime which has supported nominal growth and higher inflation and asset prices. Additionally, “value‑up” and broader corporate governance reforms are pushing management teams toward higher return on equity, cleaner balance sheets, and more shareholder‑friendly capital allocation, creating a cohort of structural winners on the long side and clear laggards that resist reform or misallocate capital on the short side. Increased corporate activity (reaching multi-year highs), creates further opportunities for catalyst and activist managers to unlock potential value.

Global macro

The surge in oil prices amid the Iran conflict has direct implications for headline inflation and acts as a tax on consumers’ real incomes. This dynamic complicates what had appeared to be a relatively clear macro backdrop. At the time of writing, markets are pricing two divergent outcomes. In one scenario, an off-ramp is found and the conflict is resolved in the near term; this could allow markets to re-engage with key drivers from earlier in the year, like central bank policy easing and resilient economic growth. In the alternative scenario, the conflict persists and keeps energy prices elevated, contributing directly to headline inflation, weighing on gross domestic product growth, and potentially influencing US mid-term elections in the months ahead. The path that emerges will be a key determinant of the policy mix going forward, with direct transmission to asset prices. Against this backdrop, nimble discretionary managers may benefit from greater potential payoffs by dynamically positioning around geopolitical and policy developments, but they also face higher risk of sharp reversals with elevated market volatility. Systematic strategies, by contrast, may benefit if elevated volatility gives rise to more persistent trends and cross-asset dispersion.