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There’s little doubt that the hedge fund sector has not been performing well. As of the end of November, the HFRI Fund Weighted Composite index was up 0.3% for the year, which trails the modest gain of just under 3% in 2014. Although aggregate returns are keeping pace with the lackluster 2015 performance of the S&P 500 index, they trailed the equity benchmark during the previous six years.
That said, investors have not exactly been racing for the exits. Data from hedge fund research firm HFRI shows that net flows into the sector have remained positive, while “an index of redemption requests, run by fund administrator SS&C, shows no significant uptick,” according to the Financial Times.
That doesn’t mean there isn’t trouble beneath the surface. Other data from hedge fund data-tracker Preqin reveals that 599 funds have shut down in 2015 and an estimated $24 billion of hedge fund assets have been liquidated. The New York Times noted that “the total that hedge fund managers have available to invest in stocks, bonds, currencies and commodities has also shrunk by the most since the depths of the financial crisis in 2008 as investors asked to pull their money out of some hedge funds and firms returned money.”
Not surprisingly, this has put pressure on fees. Citing data from JPMorgan’s Capital Introduction Group, the Financial Times reported that “management fees declined this year in every strategy except event driven, falling to a mean of 1.61 per cent from 1.69 per cent.” In at least one case, a well-known manager is providing services for free. According to the FT, Glenview Capital’s Larry Robbins, “whose fund is down 17 per cent this year, has…offered existing clients a chance to put new money into a healthcare-focused side fund, with no fees of any kind.”
Bad news is good news?
That said, the outlook seems better than it looks. The Federal Reserve’s recent interest rate hike, concerns about growth in the U.S. and overseas, turbulence in high-yield, emerging, commodity and other markets, more volatile trading conditions, political and geopolitical uncertainty, and the perception that a correction in richly-valued share prices is overdue is leading many investors to consider other options, including alternative investments, despite a recent track record that leaves something to be desired.
In a recent CNBC interview, Rich Saperstein, the CIO of HighTower Treasury Partners, an investment advisor with $8.2 billion of assets under management (AUM), said as much. Because of negative developments unfolding in a number of areas, his firm was seeking to be more conservative in 2016; among other things, it “was raising exposure to hedge funds this year as a way of getting equity participation with some protection.”
Others are apparently leaning the same way. Citing a Natixis Global Asset Management survey, Chief Investment Officer reported that institutional investors’ “primary goals for 2016 were balancing risk and return and managing volatility in investment returns.” Of those polled, 63% believed that hedge funds would perform well next year, with 41% set to invest more in the asset class than they currently do.
If a willingness to launch new products is any guide, hedge fund managers as a group are also upbeat on the outlook for their industry. In another article detailing research by consulting firm PwC and the Alternative Investment Management Association, Chief Investment Officer reported that 44%, or nearly half, of all global hedge fund and liquid alternative managers plan to market new funds, with the impetus coming from growth in AUM at their own funds and expectations that interest in the sector is set to rise.
Betting on better times
Another sign, perhaps, that hedge funds are poised for a reversal of fortunes has been the growing interest in the CTA/managed futures sector, the runt of the hedge fund litter, which was marked as a potential bright spot for 2016 in an earlier Sophisticated Investor article. As noted, the strategy has been among the sector’s biggest laggards, with negative returns during three of the past four years.
Whether investors see a change in the environment as being more conducive to this type of approach or are making a contrarian bet, the strategy has seen a pickup in interest. Citing data from hedge fund researcher EurekaHedge, Financial News noted that funds in this group have had higher inflows in 2015 than any other sector but one, representing a sharp turnaround from the year before, when they experienced the highest outflows.
In sum, the fact that market conditions are becoming more favorable to hedge fund investing as attitudes within and outside the industry improve suggest that the disappointments of the post-global financial crisis era may be nearing an end.
Michael J. Panzner is a 30-year Wall Street veteran and the author of three books, including Financial Armageddon, which predicted the 2008 global financial crisis.
