Hedge Fund Strategy Outlook: First quarter 2026

Concentration versus diversification is a major question on the minds of many investors as 2026 kicks off. Hedge funds can offer diversification, active management and alpha generation which we believe are valuable tools for investors looking to manage risk and generate differentiated returns.

1. Health care: The sector has underperformed for three years and trades at a record discount relative to the S&P 500. The regulatory environment has improved on several fronts, innovation is robust, and the merger & acquisition (M&A)/initial public offering (IPO) environment has improved, which we believe is setting up a favorable stock-picking environment.   
2. Merger arbitrage: The record-setting pace of M&A activity looks likely to continue and should contribute to attractive spreads and trading opportunities for active strategy specialists. 
3. Long/short credit: Credit managers who can remain nimble, active and can express their ideas both long and short can look to take advantage of volatility and dispersion.
    

Macro themes we are discussing

As we enter 2026, the macro landscape is defined less by a single dominant narrative and more by the collision of multiple regimes—economic, geopolitical and market‑structural—that are operating on different time horizons. Together they create an environment that is both unusually fluid and unusually path‑dependent.

1. The global cycle is drifting into an asymmetric phase.

Central banks have begun easing, but the global cycle is not synchronizing. The United States remains resilient, Europe has been stabilizing from a low base, and parts of Asia are navigating divergent policy paths. Interest-rate cuts are adding liquidity back into the system, but they are arriving at a moment when valuations—across equities, credit and alternatives—are already demanding. This creates a tension between supportive liquidity and compressed forward returns, with markets increasingly sensitive to incremental macro data.

2. Geopolitical risk is now a structural input, not a tail event.

The return of US President Trump has reset expectations around US trade policy, regulatory positioning and geopolitical posture. Simultaneously, the broader global reordering highlighted by thinkers like Ray Dalio continues to shape supply chains, capital flows and national priorities. These forces raise the probability of episodic dislocations, where geopolitical catalysts interact with crowded positioning to produce outsized price moves.

3. Markets appear calm, but underlying fragilities persist.

Surface‑level volatility remains surprisingly subdued—exemplified by a VIX² consistently below 20—even as dispersion under the surface is expanding. The calm reflects ample liquidity, strong corporate balance sheets, and a market conditioned by years of central‑bank intervention. Yet credit spreads are near historic tights, equity concentration is elevated, and several asset classes are priced for near‑perfection. These conditions leave markets prone to sharp, sentiment‑driven air pockets.

4. Structural leverage and debt burdens are becoming more visible.

Public and private balance sheets alike have benefited from the long arc of declining rates. As the world transitions toward a more normalized rate environment—even with cuts beginning—questions around debt sustainability, refinancing dynamics, and long‑duration cash flows are likely to resurface. Investors will need to differentiate between liquidity‑supported resilience and genuine balance‑sheet strength.

5. What does this mean for hedge funds?

For alternative managers, this is a market shaped by fat tails, evolving liquidity conditions and widening dispersion, both across and within asset classes. It is an environment in which we believe the ability to adapt in real time—through flexible risk budgets, diversified exposures, and disciplined portfolio construction—will determine success. The opportunity set remains rich in our view, but it favors managers who can avoid crowding, exploit volatility bursts, and operate with nimble, unconstrained playbooks.

In essence—2026 does not look like a year for static positioning. It is a year that we think will reward selectivity, agility and diversification, with hedge fund strategies uniquely positioned to extract value from a macro environment where traditional asset classes may offer more limited upside and asymmetric downside risks.

Q1 2026 outlook: Strategy highlights

Health care

Following three years of underperformance, the health care sector is trading well below its 30-year average multiple and below the S&P 500’s elevated levels, creating its deepest valuation discount to the broader market in decades. In an equity market characterized by concentration and stretched valuations, the fundamentals of health care afford an attractive entry point especially when viewed in conjunction with positive earnings revisions, robust innovation in drug pipelines, accelerating M&A with attractive premiums, and tailwinds from artificial intelligence (AI) for MedTech and diagnostics. While some unease surrounding the regulatory environment lingers, it has eased meaningfully following recent concessions by major pharmaceutical companies. Elevated return dispersion, improving fundamentals and regulatory tailwinds enhance stock-picking opportunities in a sector that investors have broadly ignored. With innovation and deal-making gaining momentum, we believe health care stands out as one of the most attractive sectors for alpha generation and stock picking in 2026.

Merger arbitrage

The merger arbitrage sub-strategy saw a material outlook improvement in the first quarter of 2026, prompted in part by the strong pace of corporate M&A activity including both strategic and financial buyers. It appears 2025 could prove to be the second-best year for M&A on record (below only the SPAC-driven mania of 2021). Activity is widespread by sector and geography. It appears likely to remain robust for the foreseeable future due to a permissible regulatory regime in the United States, ample financing availability, and the need for corporate boards and financial investors to generate earnings improvements despite already stretched valuations. Importantly, there’s a favorable relationship between deal volumes and spreads that presents both directional and active trading opportunities; in periods of elevated M&A activity, there’s usually not enough merger arbitrageur capital to collapse deal spreads, so they remain wider and more volatile.

Long/short credit

While headline credit spreads continue to hover near the tights, there are pockets of activity and dispersion happening beneath the surface. Taking November 2025 for example, there was intra-month volatility in high yield as investors absorbed evolving expectations around December’s Federal Reserve meeting, the longest US government shutdown in history, and a dip and recovery in equities. While a massive gain in CCCs drove the high yield index in 2024, CCC outperformance has been more episodic in 2025, with CCCs posting a monthly decline in November while Bs and BBs both posted a gain. Sector dispersion was also present in November with autos outperforming and technology both lagging and being and the only sector in the red. Whether future volatility breaks around rating, sector, geography, individual issuers, or other characteristics remains to be seen, but we do believe periods of higher dispersion will characterize the market environment in the coming months, which should be particularly beneficial for credit managers who can remain nimble, active and able to express their ideas, both long and short.