Assets Under Management Fall for Hedge Funds

According to eVestment LLC, investors in hedge funds and hedge funds of funds withdrew $30.8 billion in the first half of 2016, bringing down the total assets under management to $3 trillion for the entire industry.  Poor performance seems to be the driver for the redemptions.  The HFRI Fund Weighted Composite index fell 2.4% during the same timeframe.  Momentum investors, who search for "the latest hot hedge fund performer", have nothing to invest in.  Kenneth J. Heinz, president, Hedge Fund Research Inc., said that investors are also re-allocating assets due to a change in tactical or strategic investing strategy or even re-balancing assets.

The usual suspects comprised the list of the largest hedge fund managers:  Bridgewater, AQR Capital Management and Man Group.  Several managers were off the list because of divestitures (J.P. Morgan Asset Management), non-responsiveness to the survey (Davidson Kempner Capital Management, Appaloosa, Pershing Square Capital Management, Paulson & Co. and Third Point) and spin-offs (Black River Asset Management).

The same was evident in the list of hedge funds of funds manager:  Blackstone Alternative Asset Management, UBS Hedge Fund Solutions and Goldman Sachs Asset Management.  There were a couple of deals (Entrust Capital Management and Permal Group) and (Aberdeen Asset Management and Arden Asset Management) that changed the rankings of the biggest managers.  The first merger was a response to competition from investment consultants.  The strategy is to "offer specialized, unique, niche-y strategies" according to Gregg Hymowitz, chairman and CEO of EnTrustPermal.

For the first half of 2016, 58% of hedge fund managers and 63% of hedge fund of fund managers had a decline in assets under management.  Investors dissatisfaction continues as they have become increasingly focused on short term performance.

The source for this article can be found here.

Hedge Fund Hopes for 2015

Since the global credit crisis of 2008, the central banks of various nations have been using various utilities (i.e. non-existent interest rates, quantitative easing and expanding their definitions of conservative debt) to prop up asset values to protect the banking industry according to Frank Brosens, co-founder and risk manager at Taconic Capital Advisors in New York.  These actions reduced asset price volatility and hedge funds' opportunities to produce alpha.  This is now ending.  The last three months of 2014 saw increased volatility and portfolio managers are predicting it to continue in 2015.

Managers with different strategies are seeing good investments:

• Long/short
• Joel Greenblatt, managing principal and co-chief investment officer of Gotham Asset Management in New York, believes there are "..good opportunities on the short side with currently very expensive stock prices if the market drops."
• Eric Mindich, CEO of Eton Park Capital Management in New York, is long in Japanese and Chinese markets.  Both countries will benefit from cheaper oil prices and valuations are very low in China.
• Global macro - Kenneth Tropin, chairman of Graham Capital Management in Rowayton, Connecticut, is monitoring the quantitative easing initiated by Japan's and European central banks, the improvement in the US economy and unrest in various political hotspots around the world.
• Multi-strategy - Michael Hintze, CEO and senior investment officer of CQS (UK), sees short trades based on geopolitical situations (i.e. Ukraine and Russia), failling oil prices and terrorist activities.
• Credit - Several fund managers are positioning their funds on different themes.  The most interesting one is from Paul Twitchell, partner and global head of event strategies of Whitebox Advisors.  He is looking at energy-related distressed debt.  He is interested in "...supplying secured debt to energy companies at a certain price..."

The source for this article can be found at here.

Emerging Managers To Launch in 2014

Several hedge fund industry service providers are predicting 2014 to be the year of the emerging manager launch according to an article in Pensions & Investments.  These include consultants, fund of fund managers, law offices and capital introductions departments.  Experienced managers are launching new firms because their former firms are closed to new investors.  Not only are managers starting new firms, they are also hiring their investment teams at their former firms. Banks continue to divest from proprietary trading desks and hedge funds.  Investors are seeking emerging managers to meet their asset allocation target or replace their current funds according to Stephen Nesbitt, CEO of Cliffwater LLC, an alternative management consultant.   As most investment is based on relationships, they are more willing to invest with managers with a shorter history according to Dean Backer, managing director of Goldman Sachs.

Asset raising will be easier for these intact teams according to Robert Kaplan, co-CIO of the Permal Group.  The largest ones are Three Bays Capital ($500 million in assets under management) which is run by Matthew Sidman, an alumnus of Highfields Capital Management and Junto Capital Management ($317 million in AUM) which is run by James Parsons, an alumnus of Viking Global Investors.  On the horizon are Aravt Global with Wui Yen Liow, formerly of Ziff Brothers Investments, and Anand Desai, formerly of Eton Park Capital Management.  It is anticipated that they will launch with $500 million to $1 billion in AUM.  Everyone else will need to provide incentives for their seed money such as reducing their management and performance fees and offering investors equity in their business according to Tracy McHale Stuart, partner and CEO of Corbin Capital Partners, a hedge fund of funds manager.

A Sampling of Hedge Fund Views on 2014

Hedge fund managers are predicting financial markets to be more volatile and, thus, afford them more opportunities for improved investment returns in 2014 according to articles in Pension & Investments 2014 Outlook report.

Central bank intervention from the Federal Reserve, European Central Bank and Bank of Japan has kept interest rates low and caused equity prices to rebound impressively in 2013.  Their policies, along with the US budget accord and a recovered housing market, will continue to help the world economy to strengthen.  This will give investors confidence to pursue more risky assets such as emerging markets and small cap stocks.

According to Lee Ainslie of Maverick Capital, equity long/short will have better performance as the correlations between securities' returns will be lower.  Managers relying on fundamental analysis of corporates will have their positions less influenced by macro economic factors.  Other hedge funds are looking at complex strategies for returns.  Farallon Capital is investing in distressed European debt, event driven equity in merger arbitrage and US commercial real estate.  They are buying foreclosed properties and flipping them to other investors after rehabilitating and finding renters for them.  DW Investment Management will continue to hold positions in single corporate credit securities, structured corporate credit, residential and commercial mortgage backed securities and student loan backed instruments.  Magnetar Capital will invest in the US energy build out caused by the explosion of hydraulic fracturing.

Hedge Funds Replace Mutual Funds

Hedge fund and fund of funds managers have been adding long-only as an investment strategy according to an article in the December 23, 2013 issue of Pensions & Investments.  These include such famous names as CQS, Lansdowne Partners, Lone Pine Capital, Maverick Capital, Tiger Global Management, Viking Global Investors, Winton Capital Management, Blackstone Alternative Asset Management and the Rock Creek Group.  The new strategy has been driven by institutional investors - of which, 44% invest in long-only funds.  The interest has been fueled by several other factors:

• Institutional investors' disappointment with mutual fund returns
• Since the financial crisis of 2008, shorting securities has been underperforming as an investment 
• strategy
• Confidence in hedge fund managers as stock pickers
• Performance fees are easier for the manager to attain as they are based on returns relative to the performance of an index i.e. S&P 500

Blackstone and Rock Creek have almost $7 billion in assets under management (AUM) in the long-only strategy.  Both companies launched the strategy a few years ago.  In 2007, Blackstone used hedge fund managers to trade the long-only components of one of Blackstone's commodity indices.  In 2009, Rock Creek launched an emerging markets equity fund.  This fund has grown to $1.8 billion in AUM.

Hedge Funds Want Retail Investors

The number of hedge fund mutual funds or liquid alternative funds has increased from 343 at year end 2007 to 838 at year end 2012.  Assets under management are $90.3 billion, an increase of 14% over the same timeframe.  Neil Siegel, Managing Director and head of global marketing and product development at Neuberger Berman, and Evan Mizrachy, head of retail alternatives at BlackRock Alternative Investments, believe that retail investors and their 401(K) and IRA accounts are under-served by and under-allocated to alternatives.  Expanding into this segment would diversity hedge funds' client base.  On the other hand, retail investors demand daily liquidity requirements which would limit their investment universe and, maybe, performance.

According to Morningstar, the strategies run by these funds are led by long/short ($25.8 billion), market neutral ($19.5 billion), multi alternative ($17.5 billion), currency ($11.7 billion), managed futures ($8.5 billion),  short ($6.8 billion) and trading ($449 million).  Of course, these assets under management are clearly miniscule when compared to the $13.1 trillion in US mutual funds according to the Investment Company Institute.

The oldest fund, Merger Fund, has been around for 23 years using merger arbitrage strategy to give investors assets with low correlation to stock markets and volatility.  Two major institutions, FMR and Blackstone have also moved into this space.  FMR, parent company of Fidelity Management, uses Arden Asset Management to manage their alternative vehicles while Blackstone Alternative Asset Management is building their business organically.  The largest manager by far is PIMCO but their investors are mainly institutional.

The source for this article can be found at Pensions & Investments.

CalPERS Reviews Hedge Fund Strategy

The California Public Employees Retirement Systems (CalPERS) is in the midst of changing its allocation strategy for its hedge fund investments.  There are $5.2 billion in assets out of a total of $254.9 billion.  As part of its total portfolio, it is not that important but the absolute dollar numbers are impressive.  They are seeking to reduce their equity exposure by investing in assets that are not correlated with long only funds, private equity and high yield bonds.  Edigio Robertiello, senior portfolio manager of absolute return strategies, has proposed the following changes:

• CalPERS will have to raise the percentage of assets allocated to hedge funds to much more than currently
• Classifying the hedge fund allocation separately from the global equities allocation
• Limiting the beta to global equity markets to 0.20 
• Setting a standard deviation target for returns to 8%

While CalPERS is considering Robertiello's recommendations, he is reviewing the current hedge fund investments and making the following changes:

• Reducing the number of hedge funds to concentrate assets in fewer strategies
• Reducing the fund of funds allocation to 15% from 29%.  Emerging fund of funds will have a 10% allocation.
• Reducing the investments in Asia and Europe to 5% from 19%
• Increasing the allocations to equity market neutral and global macro to 10% each
• Adding an allocation to event driven to 5%
• Increasing the allocation to equity long/short to 15%

Since the portfolio has underperformed its internal benchmark by 2% since it was begun, Robertiello is hoping that the changes will improve its performance.  Against this backdrop, CalPERS is evaluating whether or not passive management is more efficient than active management.

The source for this article can be accessed here.

Housing Recovery Makes Mortgage Bonds Attractive Investments

At the beginning of the year, there was a consensus among sell side analysts, mutual fund managers and hedge fund managers that mortgage bonds that were not tied to Fannie Mae and Freddie Mac (non-agency) were the most attractive fixed income investment for 2013.  Non-agency bonds backed by subprime mortgages of the pre-2007 vintage jumped 41% last year.  High yield bonds gained 16% and agency debt gained 2.6% for the same period.  These returns were sourced from bond indices run by Barclays and Bank of America Merrill Lynch.

Major hedge funds investing or invested in these securities are Goldman Sachs Group, D.E. Shaw, Angelo Gordon, Hayman Capital and Elliott Management.  Elliott Management only sold their bonds because their yields had fallen too low.  The giants of fixed income mutual funds:  PIMCO, TCW and DoubleLine believe prices will continue to run up even though more and more investors are buying the asset class.  Projected returns for non-agency mortgage bonds are 8%.  Compare that to high yield projections (7%) and investment grade projections (3%).

The source for this article can be accessed here.

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.

Opening China to Foreign Investors

The State Administration of Foreign Exchange of the People's Republic of China has eased the rules for investing in China's financial markets through the Qualified Foreign Institutional Investor program.  They eliminated the $1 billion limitation on investments and changed the minimum statistics of the investor.  The manager must have $500 million (amended from $5 billion) in assets under management and have a track history of at least 2 years (amended from 5 years).  The entire process to obtain entrance into the program is now about 7 to 8 months.  Previously, it would take a year and a half.  The changes have been targeted to long term investors such as sovereign wealth funds, central banks, monetary authorities, insurance companies, endowments and pension plans.  Fund managers with a high turnover rate, such as hedge funds, mutual funds and investment banks, were not included in the rules changes.  Overall, by 2015, consulting firm Z-Ben Advisors Co. Ltd. of Singapore is predicting that asset management firms and asset owners will dominate the landscape.  They will push out the investment banks, who now have 51% share in the program.  Also, last year the ceiling on the program was elevated to $80 billion from $30 billion.  About $6 billion has been invested since then.  It is expected that the remaining $44 billion will be invested over the next 2 years.

The article from Pensions & Investments may be accessed here.

Allocation Targets of Public and Corporate Pension Plans

I found this interesting post on the AllAboutAlpha.com website that I access through my CAIA membership.    The author refers to two surveys on pension funds from Pyramis, a part of FMR Management, and JP Morgan.  In previous posts sourced from Pensions & Investments, pension funds are planning to allocate more assets to alternative investments.  The Pyramis study breaks down the pensions into public and corporate plans.  US public plans are allocating 13% while US corporate plans are allocating 5%.  Both figures are well below other western nations.  Canada and countries from the Nordic Region are planning a 20% allocation.

The JP Morgan survey looks at public pension funds, corporate pension funds and endowments/foundations.  Hedge funds, private equity and real estate are the major alternative investments.  Corporate pensions have a higher allocation in hedge funds (4.6% to 4.2%) while real estate (4.6% to 3.5%) and private equity (8.1% to 3.3%) are more popular with public pensions.

Hedge Funds and the Credit Crisis

The RAND Group published a paper examining the role of hedge funds during the credit crisis of 2008.  The question was whether or not funds create or contribute to the systemic risk that caused it.  This was triggered when Lehman Brothers declared bankruptcy and caused the financial markets to melt down globally.  The researchers reviewed that crisis and the 1998 private bailout of Long Term Capital Management orchestrated by the Federal Reserve.  They found six areas of concern:

• Lack of information on hedge funds
• Lack of appropriate margin in derivative trades
• Runs of prime brokers
• Short selling
• Compromised risk management incentives
• Lack of portfolio liquidity and excessive leverage

Dodd-Frank legislation was passed to handle these issues to avoid new crises in the future.  To create more transparency on hedge funds, the reform was to require funds with $150 million in assets under management to register with the SEC.  However, there is a loophole as non-US hedge funds with no offices in the US and less than $25 million invested from US investors were exempt from the reporting requirement.  There is pending legislation from Europe that would affect those hedge funds but no reform in Asia is anticipated.  Funds are to submit the following data points:  assets under management, total leverage, counterparty credit risk exposure, trading and investment positions, asset valuation processes, asset types, side arrangements or letters with investors and trading practices.  Additionally, the SEC would have periodic inspections of the fund.  Since derivative trades were at the center of the crisis, swap trades need to be registered in a central repository. 

The CFTC and SEC would impose minimum capital restrictions on these trades and the funds must trade them on an exchange if possible.  To prevent funds from closing their prime brokerage accounts, their accounts would be segregated from the prime broker’s funds and rehypothecation of assets would not be allowed.  Rehypothecation is when the prime broker uses the hedge fund’s assets for its own business such as securities lending or as collateral. 

Short selling rules will be enforced to prevent bear raids on a stock.  When a stock falls 10% or more in price from the prior day’s close, then the uptick rule will be triggered.  This rule restricts short sales to when the stock price is above the last sale or the best bid price.   In a short sale, the stock must be borrowed first.  These shares must be delivered by the settlement date (within three days) of the trade.  There must be monthly disclosure of short positions aggregated by stock. 

Dodd-Frank also limits bank investment in hedge funds to three percent of the fund’s assets and three percent of the fund’s tier 1 capital.  Hopefully, this will prevent banks from bailing out their funds.  This is true from a financial perspective but banks may be motivated to bail them out to mitigate reputational risk.  These restrictions are only applicable to US entities.

To address the liquidity and leverage concerns, large hedge funds with $50 billion or more of assets under management are candidates to be regulated by the Federal Reserve Bank.  These funds are determined by the Financial Stability Oversight Council who assesses them based on a wide range of factors; quantitative and qualitative, industry and firm-based and the Department of the Treasury.  If two thirds of the council plus Treasury agree, then the fund will be regulated.  There will be position limits on futures and options for physical commodities and annual stress tests for funds with $10 billion in assets under three scenarios – baseline, adverse and severely adverse.  Regulating the prime brokers of hedge funds indirectly addresses leverage.  They will have higher capital requirements and have less credit to extend to funds, limiting their available leverage.

The reforms are changing the way hedge funds operate.  This is ironic as they did not cause the credit crisis.  The gap is in the potential lack of portfolio liquidity and excessive leverage.   There is too long a time delay before reporting positions.  The number of funds covered are few.  Prime brokers and regulators will have incomplete data as funds use multiple brokers and home countries.   Of the other points, lack of information, lack of margin on derivative trades and runs on prime brokers are strongly addressed and short selling and risk management incentives are moderately addressed.  Regulators should continue analyzing the hedge fund universe to better understand and monitor their risk.

The source for this article can be accessed here.

Asset Allocation Trends in Public Pensions

In the October 1, 2012 issue of Pensions & Investments, I noticed an interesting statistic in an article about the funding ratios of public pension plans.  The weighted average asset allocation of the top 100 plans in Pensions & Investments' universe for 2011 is as follows:

• US Equities - 21.6%
• Global Equities - 16.9%
• International Equities - 13.2%
• Fixed Income - 23.9%
• Private Equity - 7.5%
• Real Estate - 6.3%
• Hedge Funds - 2.3%
• Real Return - 1.2%
• Commodities - 0.4%
• Cash/Other - 4.4%

The target allocation for the same year was as follows:

• US Equities - 15.7%
• Global Equities - 23.6%
• International Equities - 9.7%
• Fixed Income - 25.2%
• Private Equity - 7.3%
• Real Estate - 7.6%
• Hedge Funds - 2.8%
• Real Return - 1.6%
• Commodities - 0.6%
• Cash/Other - 2.9%

The weighted average asset allocation 2007 is as follows:

• US Equities - 36.5%
• Global Equities - 6.0%
• International Equities - 17.4%
• Fixed Income - 25.3%
• Private Equity - 5.2%
• Real Estate - 5.7%
• Hedge Funds - 0.9%
• Commodities - 0.2%
• Cash/Other - 2.8%

The biggest losers from 2007 to 2011 were US and International Equities.  Global Equities, Private Equity, Real Estate, Hedge Funds, Real Return and Commodities were net gainers.  Based on the target allocations, we can expect more investment in Global Equities, Real Estate, Hedge Funds, Real Return and Commodities.

The source for this article can be accessed here.

Hedge Funds Are Not An Asset Class

Capital Generation Partners (CGP), an investment advisory firm, analyzed portfolio diversification ideas.  They concluded that there are only three asset classes:  debt, cash and equity.  Alternative investments such as hedge funds should not be classified as an asset class.  They should be classified based on their underlying positions.  Hedge funds are merely investment strategies for these assets.  There are four strategies based on two points:  directional versus arbitrage and systematic versus discretionary.  These four strategies and three asset classes combine to create twelve buckets.

Equities
directional & discretionary - equity long/short, long only, real estate, private equity and 130/30 funds
directional & systematic - equity index trackers and quantitative funds
arbitrage & discretionary - equity market neutral and event/risk arbitrage
arbitrage & systematic - equity statistical arbitrage and systematic CTAs

Cash & Commodities
directional & discretionary - global macro, physical commodities and currency (carry) trading
directional & systematic - trend following CTAs, commodity ETFs and money market funds
arbitrage & discretionary - commodity/macro curve trading and volatility arbitrage
arbitrage & systematic - statistical arbitrage and systematic CTAs

Fixed Income
directional & discretionary - fixed income long/short and distressed debt
directional & systematic - bond indices
arbitrage & discretionary - global macro and structured credit
arbitrage & systematic - fixed income arbitrage and systematic CTAs

Proper diversification includes having non-correlated assets in a portfolio.  CGP analyzed returns from 2000 to 2010 for the twelve categories.  Their conclusions were:

• Alternative investments are not real diversifiers of a traditional equity/fixed income portfolio
• Hedge funds should be allocated across the twelve categories and not be treated as a separate asset class
• Fund managers should be closely monitored for style drift
• Correlation map indicates that larger allocations should be made to hedge funds

The correlation heat map from the paper confirms an earlier study by Welton Investment Management.  Global macro and managed futures (Barclays CTA Index in this case) are not correlated to other hedge fund strategies.  In CGP's chart, equity market neutral can be added.

The source for this article can be accessed here.

How Hedge Funds Perform When the VIX is High

In a recent article  published in the Alternative Investment Analyst Review, Mikhail Munenzon, CFA, CAIA, PRM and Director of Asset Allocation and Risk at the Observatory, researched how different hedge fund strategies performed during periods of volatility over twenty years.  The data came from the Center for International Securities and Derivatives Markets Indices.  The strategies covered were convertible arbitrage, distressed, merger arbitrage, commodity trading advisor, macro, equity long/short, equity market neutral, emerging markets and event driven.  He looked at the indices for traditional assets too:  S&P 500 Index, JPM Morgan Aggregate Bond Total Return Index, SP GSCI Commodities Index and the FTSE EPRA/NAREIT US Total Return Index, a real estate index. Volatility was measured by the VIX index from 12/31/91 to 1/29/10.  Munenzon created six categories:  less than 20, 20-25, 25-30, 30-35, 35-40 and more than 40.  The VIX was under 30 90% of the time and under 20 50% of the time.  Based on the data, it does not jump randomly from being quiet to being volatile.  They remain calm or volatile at times and remain so for the near future.  Each index's return was analyzed during the same timeframe.  Here are the most important points:

• Only four of fourteen indices had positive returns in all conditions:  commodity trading advisor, macro, equity market neutral and JPM Morgan Aggregate Bond Total Return Index
• Superior long term performance of hedge funds are due their ability to limit their losses during times of market stress due to unconstrained investing.
• This affirms an earlier study by Welton Investment Management stating that macro and commodities are the two strategies that are not correlated with the stock markets

Please note that data is based on indices.  Individual portfolios of funds may have different results.

Growing Emerging Hedge Funds

I have been invited to be a guest author on another blog:  Simon Kerr on Hedge Fund.  The article, seed capital for hedge funds, can be accessed here.

Assets Surge into Activist Hedge Funds

According to an article in Pensions & Investments, institutional investors have started the trend of classifying their asset allocation to alternative investments based on their type of asset (equity, fixed income or commodities) instead of in a separate bucket.  This has fueled an increase of capital into activist hedge funds such as ValueAct Capital Management. Starboard Value and Cevian Capital in the second half of 2011 and first quarter of 2012.  The reasoning behind placing them into the equity classification is that they hold long positions.  The Florida State Board of Administration recently invested $125 million in Starboard.  The New Jersey Division of Investment, New York State Common Retirement Fund and Virginia Retirement System placed $600 million with Cevian Capital.  Overall, the investments in managers with a constructive approach are larger than the more aggressive approach favored by Bill Ackman of Pershing Square Capital Management and Daniel Loeb of Third Point.  Some of the larger funds that work with company management to improve their share price are Cevian Capital, JANA Partners and Paulson & Company.

Activist hedge fund managers keep their holdings for a longer period of time than other fund managers.  They need time for their campaigns to improve the value of the stock.  According to Stephen Nesbitt, CEO of Cliffwater LLC, the strategy has strong, uncorrelated returns in the last five years.  For a sample selection of eight funds, the return was 8.6%.  The Russell 3000 Index's return was 0% and the Morgan Stanley Capital International All Country World Index returned 2.8% for the same time period.  This is a natural attraction for pensions, endowments and foundations.

Notes from a Hedge Fund Survey - Part II

SEI and Greenwich Associates conducted a survey of institutional investors and hedge funds.  Part I was summarized earlier.  Part II was released later and dealt with issues on investing, institutional standards for fund evaluation, selection and monitoring.  105 investors participated in the survey.  They could be classified as endowments, foundations, family offices, corporate funds, public pension funds, consultants, union plans and non-profit organizations.  85% of the institutions are located in the US with some in UK, Canada and Scandinavia.  Their assets under management (AUM) fit into four bands:

• 42.2% had less than $500 million
• 15.5% had $500 million to $1 billion
• 25.4% had $1 billion to $5 billion
• 16.9% had more than $5 billion

The new top three challenge for investors is manager selection.  This is due to the increasing number of hedge funds being launched due to the recovery in the markets and Graham-Dodd legislation.  Many have indistinguishable strategies.  If a manager can define his unique strategy to investors in understandable terms, he is ahead of other funds.  In terms of the criteria for selecting managers, investors emphasize investment philosophy, the quality of the personnel on the investment team, risk management and having an identifiable, repeatable source of alpha.  AUM of a fund is low in importance for investors when choosing a fund.  20% have no AUM minimum and 15% have a $50 million to $100 million minimum.  The age of the fund does not seem to affect investors.  According to the survey, 14% would invest in a fund with no record and 24% in a fund with one to three year record.  Large institutions are more willing to hire emerging managers.  Smaller investors favor larger, more established funds.  Smaller investors also are more likely to hire investment consultants for their advice.  Larger investors are more likely to invest directly in hedge funds.

The other worries have remained the same since the credit crisis in 2008 - portfolio transparency, poor performance, leverage, risk management and liquidity.

Hedge Funds and ETFs

Some high profile hedge funds use ETFs (Exchange Traded Funds) and ETPs (Exchange Traded Products) as part of their investment strategy.  These luminaries include Bridgewater Associates, Eton Park Capital Management, Lone Pine Capital, Millennium Management, Oak Hill Investment Management and Paulson & Co. according to their 13-F filings with the Securities and Exchange Commission (SEC) in December 2011.  Why would these managers use these efficient and low cost securities, risking the ire of their investors who are paying them "2 and 20"?  They are used to:

• Used as a temporary investment while individual securities are picked.  They allow the manager to invest quickly in the space before establish stock specific positions.
• Invest in markets or sectors where the manager does not have the infrastructure for detailed research or specific knowledge
• Arbitrage a security
• Mask their trades by using a large ETF
• Invest based on macro opinions
• Get exposure on a sector level when individual securities' correlations are high
• ETFs have liquidity which allows managers to trade out of positions easily
• Establish a position in sectors or regions with low liquidity and buying securities is hard
• Hedge a position

Depending on the fund strategy, fund of fund managers and investment consultants view ETF usage as positive for global macro and systematic trading strategies and negative for fundamental stock pickers.  Equity long/short managers are receiving the "2 and 20" to pick securities, not to be an index fund.

Top 5 ETFs Held by Hedge Funds

• SPDR Gold Shares (GLD)
• Vanguard ETF Emerging Markets
• Market Vectors ETF Gold Miners
• Vanguard Total Bond Market ETF
• Powershares QQQ

Top 5 Shorted ETFs by Hedge Funds

• SPDR S&P 500 ETF SPY Index
• iShares Russell 2000 Index Fund IWM Index
• Energy Select Sector SPDR Fund
• Financial Select Sector SPDR Fund
• SPDR S&P Midcap 400 ETF Trust

The source for this article can be accessed here.

Status Report: Institutions Increasing Allocations to Hedge Funds

According to an article at Pensions & Investments, several pension funds are increasing their portfolio allocation to hedge funds.  The favored strategies are equity long/short and credit strategies.  Florida State Board of Administration, State of Wisconsin Investment Board and North Carolina Retirement Systems have invested in equity long/short.  The funds winning these mandates can be found here.  Despite negative returns for equity long/short in the HFRI Equity Hedge Fund index for 2011, investors are not planning any withdrawals.  The total amount being invested is $2.5 billion.

There are several reasons for institutions to increase their allocations:

• Hedge funds are no longer a discrete asset class but are classified as equity or fixed income based on their holdings
• Equity long/short funds reduce the volatility of returns
• Fixed income long/short funds generate excess returns (alpha) on the long and short sides of trades