Most Popular Hedge Fund Strategy is Relative Value

Assets under management for hedge funds using the relative value strategy have surpassed the equity long/short strategy for the first time in the fourth quarter of 2012.  As of September 30, both strategies had a market share of 26.7% of the $2.192 trillion hedge fund industry.  The next most popular strategies were event driven at 24.5% and macro at 22.1%.  To give you a sense of where equity long/short was coming from, it was 56.3% of all assets under management for hedge funds in 2000.  Several factors accounted for the shift:

• Investors reducing their exposure to equities to diversify and reduce their portfolios' volatility
• Investors investing directly into hedge funds and away from fund of hedge funds, which are heavily weighted towards equity strategies
• Underperformance of equity long/short strategy over the past five years

Year	HFRI Equity Index	HFRI Relative Value Index
2008	(26.65)%	(18.04)%
2009	24.57%	25.81%
2010	10.45%	11.43%
2011	(8.38)%	0.15%
2012	7.39%	10.04%

Funds that have experienced significant inflows include BlueMountain Capital Management, Pine River Capital Management, Marathon Asset Management, MKP Capital Management and Brigade Capital Management.

However, for 2013, several investors are reviewing the value proposition of equity long/short funds.  Fixed income returns are projected to be low and stockpickers will be in vogue again as macroeconomic moves such as Quantitative Easing 3 fade.

The source for this article can be accessed here.

Notes from a Hedge Fund Survey - Part I

Last month, SEI and Greenwich Associates published part 1 of the Fifth Annual Global Survey of Institutional Hedge Fund Investors.  There were several themes that emerged from the report for investors.

• Allocations to hedge funds are rising but at a slower rate than last year.  In 2012, they are projected to be 17.8% of investor portfolios.  They were just 12% in 2008.  The increase is led by endowments.
• The top goal for institutions for hedge fund investing is absolute return in 2011.  This was in response to the poor performance of the HFRI Index.  In prior years, the goal was to mitigate risk by investing in non-correlated assets.
• Investors use hedge funds to manage their investment risks through diversification among investments to decrease volatility
• More institutions are investing directly into hedge funds rather than funds of hedge funds.  According to Citi Prime Finance, investors are unhappy with paying an additional layer of management and incentive fees, are concerned that funds of funds are too diversified and want to have more control over their portfolio.  The larger institutions have the resources to invest directly.  Of the smaller ones (less than $500 million AUM), 64% use funds of funds.
• Most popular strategies are the simpler ones:  equity long/short, event driven and credit
• Limited interest in re-allocating to UCITS or mutual funds
• The most important challenge for hedge fund investors is having performance expectations met.  This is probably in response to the 2011 performance.  In 2010, when returns were good, then transparency was important.

Mutual Fund of Hedge Funds

Hatteras Funds manages $2.1 billion in the alternative investment space.  One of its products is mutual fund of hedge funds.  FINalternatives posted a recent interview with the President of Hatteras Funds, Bob Worthington. Their funds invests in five strategies:  long/short equity, equity market neutral, relative value long/short debt, event driven and managed futures.  The hedge funds have between $25 to $500 million in assets under management.  The mutual fund is diversified with 23 managers in a portfolio of $550 million.  Hatteras thinks that they can manage $5 billion in assets with 35 managers.  The managers have to meet compliance/risk control standards as well as being a good fit in the overall portfolio.

The mutual fund has daily liquidity.  This allows great flexibility in determining a tactical asset allocation.  Hatteras usually does not make adjustments on a daily or weekly basis but they can adjust if market conditions change dramatically.  The fund increases liquidity and transparency when compared to more illiquid fund of fund or hedge fund vehicles but has less risks and returns.  However, the fund gives the investor access to hedge fund strategies.

The article can be accessed here.

Institutional Investors Favor Long/Short Equity, Macro and Special Situations in 2012

The following chart was published on Pensions & Investments Online website from Deutsche Bank's 2011 Institutional Survey.  1 in 4 institutional investors will be adding to its hedge fund investments in 2012.  Long/short equity, macro and special situations seem to be the most popular.  Distressed and long/short credit are the least.

The source for the article can be accessed here

Is Your Portfolio Truly Diversified?

During the credit crisis of 2008, all assets (equities, fixed income, real and alternative assets) declined in value.  Welton Investment Management wrote a research report regarding asset allocation.  According to Modern Portfolio Theory, the most efficient portfolios have assets that are not correlated.  This minimizes any excessive decrease in assets during a crisis.

They tested this theory by taking 24 indices representing the 4 asset types and calculated the correlation of returns over 10 years across 2.5 business cycles.  They discovered that 80% of alternative assets and 75% of real assets were correlated with stock returns.  The alternative assets were private equity, event driven, long/short equity, distressed securities, multi-strategy, fixed income arbitrage, convertible arbitrage and risk arbitrage.  Only global macro and managed futures were non-correlated.  For real assets, infrastructure, real estate and TIPS (Treasury Inflation Protected Securities) were correlated.  Commodities was the only real asset that had non-correlated returns against equities.

The 4 revised asset types should be:

• Equities, correlated alternative and real assets
• Global macro and managed futures funds
• Commodities
• Fixed income

The research report may be accessed here.

2010 Hedge Fund Industry Review

Credit Suisse recently published their 2010 Hedge Fund Industry Review.  In a previous post, we had mentioned that the Dow Jones Credit Suisse Hedge Fund Index had returned 10.95%.  The good performance of hedge funds has investors returning.  Hedge funds have returned 31.55% since the bottom of the markets two years ago.

Of the ten strategies tracked, eight had positive returns with Global Macro, Event Driven and Fixed Income Arbitrage leading the way.  Global Macro funds used two themes for investing ideas:  intervention by central banks and commodities.  Event Driven funds using the Distressed Debt strategy found better investments due to the European debt crisis.  Fixed Income Arbitrage managers took advantage of the intervention by central banks to find investing opportunities.

The most successful strategies:  Global Macro and Event Driven received the most interest from investors.  Global Macro had $16.8 billion in asset inflows and Event Driven had $13.8 billion.  Multi-Strategy had $16.9 billion in outflows.

Small funds with assets under management of $100 million have outperformed large funds (with $500+ million AUM) by 3.95% annually.  They may be nimbler than large funds - being able to quickly get in or out of positions due to the smaller size or less bureaucracy - or they may be riskier.  During major market moves, the outperformance is more pronounced.  When markets are quiet, large funds perform on a par with smaller funds.

The research report may be accessed here.

2010 Annual Report: Hedge Fund Returns

Dow Jones Credit Suisse Hedge Fund Index had a return of 10.95% in 2010.  The index is composed of more than 8,000 funds.  The Global Macro strategy led the way with a 13.47% performance.  Other strategies that did well were:  Event Driven, Fixed Income Arbitrage and Managed Futures.  Details may be found here.

You can find an interesting side note here.  The Dow Jones Industrial Average outperformed the hedge funds with a return of 14.06%.

Event Driven Strategy - Merger Arbitrage and More

The event driven strategy invests in a wider range of situations than merger arbitrage.  Merger arbitrage managers are concentrated on mergers and acquisitions.  Event driven managers may invest in firms that are:

• In the middle of a reorganization
• Spinning off a division
• In bankruptcy
• Starting a share buyback program
• Distributing a special dividend
• Specific news announcements such as earnings restatements
• Significant market events

Again, the manager is trying to exploit mispricings of the company's securities due to these one-time events.  Another term for this strategy is special situations.  Some sources state that merger arbitrage is a substrategy of event driven.  I can see the logic behind this.  However, for these articles, I am using the definition promulgated by the Chartered Alternative Investment Analyst program (at www.caia.org) and has these as separate strategies.