Transitioning back to growth – the industry positions for a second wave of allocations.
Performance-led recovery for the industry as a whole
From a funds under management (FUM) low point of around $1.3 trillion at the end of March 2009, the industry began a sustained, performance-led recovery to end March 2010 with FUM of $1.67 trillion.
Over the period, the industry saw net outflows of around $14 billion, but was able to regenerate momentum through performance. The return of liquidity and counterparty confidence to the markets enabled managers across many styles to record strong performances in 2009. Fund of fund index performance was up 11.5% over calendar year 2009, with notable style contributions from equity long/short (+24.5%) and event driven (+25.0%).
Into 2010, the picture has been more mixed, as a differentiated recovery continues. The dispersion trade is now firmly centre stage as managers across styles look to exploit differentials between corporates, commodities, currencies and nation states. Investors are showing preferences for styles which are nimble, pragmatic and liquid. Equity hedge and event driven were the main beneficiaries of calendar first quarter 2010 flows.
Our own research into hedge fund managers' trading activities over the last year has shown that returns have been generated across a wide range of positions, sectors and regions with no single theme dominating aggregate risk exposures in our multi-manager portfolios. There has been no one-way beta bet on the equity market rally, or sovereign default, and some of the best performing strategies have constructively and methodically sought out undervalued securities or arbitraged mispricings. In a post crisis and more normally functioning market, experienced managers have maintained overall lower gross exposures and modest long to net neutral positions. With the retrenchment of bank's trading desks and fewer peers for competition, there are fewer market participants to trade greater opportunities.
Not all funds have shared equally in the recovery. By the end of 2009, an estimated 2,000 funds had liquidated since the inception of the financial crisis. There has been a shake-out, with pre-2008 industry participants now in three groups.
- Those that have not made the grade
- Those who benefited from a performance lifeline, but remain under-prepared for the changed investment landscape
- A select group of firms who are able to demonstrate multiple year track records, institutional quality infrastructure and the confidence of counterparties and regulators.
It is notable that the bulk of inflows in the first three months of 2010 were concentrated with firms greater than $5 billion (5.1% of all funds), which now manage over 62% of industry capital.
The benefit of perspective and the early signs of a second 'wave' of hedge fund allocations
Above all, recent events have enabled investors to put 2008 performance into perspective and have decisively re-affirmed the defining characteristic of hedge fund investing: to take advantage of multi-directional market opportunities, while actively managing downside risk.
On a three year annualised basis until the end of March 2010, fund of hedge fund index performance is down 1.7% with an annualised volatility of 7.7%, while world stocks are down 7.7% with an annualised volatility of 19.6%. The picture is stronger still for individual styles. Over the same period, AHL, as a leading exponent of the managed futures style, is up 12% with an annualised volatility of 16.5% and with a correlation to world stocks of –0.25 over three years.
For private investors looking at portfolio diversification and newly mindful of stock market volatility, as much as for pension schemes, insurance companies and university endowments looking at longer term liabilities and funding gaps, the compelling nature of the risk/return profile of hedge fund styles and hedge fund investing techniques is beginning to drive renewed interest. Throughout the period, survey evidence has underscored this. For example, in February 2010, 80% of North American investment consultants, representing around $5.6 trillion of assets under management, predicted strong or moderate search activity in relation to hedge funds and fund of funds.
We have begun to see this trend underscored by allocations. Man itself towards the end of the period announced $1.5 billion in new investment mandates from institutions seeking to marry a conviction view on hedge funds, with the benefits of Man's managed account platform.
Building trust and confidence to unlock allocations
For investors to re-engage with the asset class, it is clear that they need to develop similar levels of trust and confidence in allocating to hedge fund styles as they have in allocating to more traditional investments in equities and bonds.
Key to generating and maintaining this trust and confidence are:
- Enhanced transparency
- Security of assets
- Control and flexibility in portfolios (often with high levels of liquidity)
- Well understood and locally regulated product formats
- Demonstrable financial strength
- Business sustainability on the part of managers
Managed accounts have been a key tool in delivering the first three of these and the focus of significant industry commentary throughout the year. Man's managed accounts offering is investment led, independent and scaleable, and positions us well to benefit from industry-wide increases in FUM in MAC format. Investment Management – Multi-Manager
Providing hedge fund investment exposures in established formats and brands familiar to investors from their more traditional investment allocations has been a further much publicised theme over the period.
UCITS, a pan European regulated product format with a global market size of around $7 trillion, has been a particular focus for commentary. While much of the media focus has been on UCITS, in practice 'onshorisation' of hedge fund content is a global phenomenon. Man's worldwide local presence positions us well, as new territories develop frameworks to allow a wider audience to access hedge fund benefits. Investor Solutions
