Most Consistent Top Performing Hedge Funds & Forecast For 2016 by Preqin

Hedge Fund Industry Forecast For 2016

In November 2015, Preqin conducted surveys with over 500 hedge fund managers and institutional investors from across the globe to ascertain their views on the hedge fund industry and their outlook for the year ahead. In this article, we take a closer look at some of the key trends that emerged from the survey results as we make our predictions for the year ahead.

Hedge Fund Performance Will Be under the Microscope

The performance of the hedge fund sector is likely to come under even more scrutiny in 2016. Investor satisfaction with the performance of their hedge fund portfolios declined from the end of 2013 to the end of 2014, and at the start of 2015 Preqin noted that it would be a year for hedge funds to show what they are worth. For many investors, this was not achieved: 33% of investors reported that their hedge funds had not met expectations in 2015, compared to 35% that reported the same in 2014 (Fig. 1). In addition, 40% of fund managers believed their return objectives had not been met in 2015 (Fig. 2). However, despite the Preqin All-Strategies Hedge Fund benchmark adding just 2.02% in 2015, its lowest level since 2011, the value of hedge fund investment is becoming more evident, in many ways, in light of recent events in traditional equity and fixed income markets. Hedge funds outperformed many global indices such as the S&P 500 Index, MSCI World Index and Barclays Capital Global Aggregate Bond Index in 2015, and the turbulence in leading markets has continued into 2016. In the current environment, if hedge funds can prove their value as a product that can help preserve assets, reduce portfolio volatility and provide a risk-adjusted return stream, then those investors that are currently taking a cautious approach to the asset class may indeed reconsider their outlook.

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Fundraising to Become More Challenging in 2016

Hedge funds have had a second year in which performance has disappointed a large number of investors (see Fig. 1). These concerns have led to signs that fundraising could become extremely challenging in 2016; more investors have indicated that they intend to invest less capital in 2016 than in 2015 (Fig. 3) – an early sign there may be net outflows over the year. Although investors recognize the long-term benefits of hedge funds within their portfolios, if fund search activity declines in the short term, finding and gaining the attention of those investors looking to make new investments will be vital if fund managers are to accumulate fresh assets over 2016.

Coupled with an increasing number of investors indicating that they will reduce the size of their hedge fund portfolios in 2016, investors that have fresh investments planned have indicated that they will invest smaller sums in fewer funds than in previous years. Sixty-five percent of investors will be investing less than $50mn of fresh capital in hedge funds in 2016, an increase from the previous year (54%). In addition, the proportion of investors investing $250mn or more has decreased from 15% in 2015 to 8% in 2016. In contrast, 42% of fund searches planned for 2016 are for one or two funds – an increase from 32% on the previous year. Again, this highlights that 2016 could potentially be challenging for fund managers looking to grow, as institutional investors have indicated that they will placing smaller sums of capital in the hands of a smaller number of hedge fund managers.

Despite a challenging outlook on fundraising in 2016, fund managers are largely optimistic that the industry will grow in 2016: 72% of fund managers believe that industry assets will increase next year (Fig. 4).

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CTAs, Macro Strategies and Equity Strategies May Have a Successful 2016…

Although fundraising looks set to be challenging in 2016, there are some fund types and strategies that may have a more successful year than others, in terms of capital inflows from investors. Fig. 5 shows the breakdown of investors’ plans for their portfolios by strategy in 2016. The chart shows whether investors plan to add or increase their exposure to strategies in 2016, or reduce or cut their exposure, as well as whether investors have no exposure to the strategy. The more liquid strategies are the most attractive to investors in 2016 – equity strategies, macro strategies and managed futures/CTAs all look set to see the largest inflows in 2016 (Fig. 5).

Equity strategies funds are planned by a significant proportion of fund managers: 43% of respondents with a new fund planned are looking to launch an equity-focused fund in 2016 (Fig. 6). Correspondingly, equity strategies funds are expected to be the best performing in 2016; 26% of fund managers believe it will perform the best in 2016, ahead of the next largest proportion (17%) of fund managers that believe macro strategies will perform the best in 2016 (Fig. 7). In contrast, however, fund managers have a mixed outlook on the success of CTAs in 2016: approximately equal proportions believe it will be the best and worst performing strategy over this year.

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…However Credit Strategies May Struggle in 2016

At the other end of the spectrum, a larger proportion (15%) of all investors in credit strategies plan to reduce their exposure rather than increase or add these funds (4%) to their portfolios over 2016 (Fig. 5). This indicates that we could see outflows from these strategies in 2016.

The fund managers that Preqin interviewed at the end of 2015 also expect credit strategies to struggle in 2016 – one-third of managers are tipping these funds to be the worst performers over the course of the year (Fig. 7). A similar proportion (30%) made the same forecast at the end of 2014 and yet credit funds outperformed some other strategies for much of 2015, ending the year with a 12-month return of 2.46%.

It will be interesting to see if fund managers are proved correct in 2016, with the planned tightening of monetary policy by the US Federal Reserve and its consequences uncertain.

Fees Are Likely to Remain Contentious in 2016

With performance proving challenging in 2015, and investor satisfaction with hedge fund returns failing to improve over the year, our survey indicates that institutional investors will continue to press for further reduction in both management and performance fees in 2016. Approximately 14% of investors regard fees as the key issue facing the hedge fund industry going into 2016, making it the third most important issue behind performance and transparency. Many of the more high-profile exits of institutional investors from the hedge fund industry in recent years, most notably CalPERS
in 2014 and Railpen in 2015, cited costs and fees incurred by investing in the asset class among the reasons for their redemptions, and therefore the perceived lack of value provided by hedge funds.

In recent years, the 2/20 fee structure, once synonymous with the asset class, has gradually given way to a wide range of terms of remuneration, reflecting the variety of fund types now available to investors in hedge funds and the high level of competition in the hedge fund market. As shown in Fig. 8, we have seen a general downward movement of management and performance fees by year of inception. However, we did note an increase in mean management fees for funds launched in 2015 to levels that have not been seen since 2012.

Many investors still see room for improvement in terms of fees. When asked which areas of fund terms had improved the most over 2015, management fees were most commonly cited (58% of investors, Fig. 9). However, management fees was also the most common answer when investors were asked which area of fund terms and conditions they want to improve further in 2016, as cited by 46% of investors. Similarly, although 35% of investors reported improvements in the level of performance fees, 42% would like to see performance fees reduced further over the coming year. This indicates that while there has been continued movement in the right direction regarding the level of management and performance fees, there remains clear demand for further improvements over 2016.

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Most Consistent Top Performing Hedge Funds

Methodology

These funds were determined as the most consistent by using a percentile rank methodology, whereby each of four metrics (annualized return, annualized volatility, Sharpe ratio and Sortino ratio) were representatively graded in a sample population of all hedge funds with performance data on Preqin’s Hedge Fund Analyst database over two sample periods. The ‘average score’ of each fund was then  derived through an average of the four percentile values and solely used to determine fund consistency. Where a Sortino ratio could not be calculated due to the fund not generating a negative return in the sample period, the fund was given a percentile score of 100 for its Sortino ratio metric.

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Editor’s View – Industry News

In our feature article, we took a closer look at the key trends that might emerge in the hedge fund sector in 2016 based on our end-of-2015 interviews with fund manager and investors. In this month’s Editor’s View, we examine how the year is panning out so far in regards to the predictions we made in our trend forecast.

Performance in January

As our benchmarks show (page 13), the start of the year proved challenging for many hedge funds. The Preqin All-Strategies Hedge Fund benchmark made a loss of 2.60%, and all leading hedge fund strategies, except macro strategies, were underwater for the month. CTAs, in contrast, made gains of 1.38%. Among the CTAs that had a strong start to the year were Insch Kintore, managed by Switzerland-based fund manager Insch Capital Management. The fund, launched in January 2015, made gains of 18.48% in January 2016, continuing its successful performance in 2015, when the fund added 17.34% in its first year of inception. The fund that topped Preqin’s league table for performance in January 2016 is Forum Global Opportunities Fund – Class A – Series 1, a macro strategies vehicle incepted in 2005. The fund is managed by Forum Asset Management and focuses on discretionary global macro with an emphasis on emerging markets. The fund seeks to create value through a portfolio of diverse investments across debt, interest rates, equity, currencies and commodities to generate returns uncorrelated with the broad markets. In January 2016 it returned +29.84% for its investors.

Fundraising Challenges

As our interviews with institutional investors indicated, fundraising could become more difficult in 2016 as fewer investors indicated that they plan to increase their investment in hedge funds than decrease their exposure. For fund managers active in the sector it may become more challenging to identify which investors are likely to be active in hedge funds in the next 12 months. Preqin tracks over 5,000 institutional investors active in hedge funds and our team of analysts have hundreds of conversations with investors every week to find out more about their plans for their hedge fund portfolios. From our January and February interviews with investors we identified over 100 institutions that have new investments planned for the rest of the year. Among these is US-based fund of funds, Steben & Company. The $740mn firm will focus on CTAs in 2016; however, it will also seek managers that employ equity market neutral, long/short equity, global macro, fixed income and relative value investment strategies. Another investor searching for new funds in 2016 is Movestic Kapitalforvaltning. The Sweden-based asset manager will be adding between one and three new funds to its portfolio over the course of the next 12 months.

Fees

With performance continuing to be a concern for investors and fundraising becoming challenging in 2016, the issue of fees is unlikely to subside, as institutions continue to call for the standard 2/20 to move towards a more acceptable level. In 2016 we have already noted 63 new fund launches (as of 15 February 2016). Among these is Altis Pure Trend, a Jersey-domiciled CTA managed by Altis Partners. The fund has three institutional share classes (available in USD, GBP and EUR), each with a 1% management fee and no performance fee.

Chart of the Month

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Despite investor pressure for reduced fees likely to be a key challenge for 2016, which could lead to the need to cut costs, 84% of hedge fund managers intend to invest more money in their businesses in the year ahead. Our Chart of the Month shows which areas of their business they plan to invest more capital in over the course of 2016. Forty-one percent of fund managers plan to invest more in their portfolio management capabilities in 2016. With successfully navigating market volatility in order to generate better performance a key challenge for 2016, this investment in portfolio management may be necessary in order to improve this aspect of their hedge fund businesses. The same proportion (41%) intend to invest more capital in their marketing and business development capabilities. Fundraising could become more challenging in 2016 as many investors are taking a cautious approach to investing in the asset class; hedge fund managers look set to try to win a share of what inflows there are through increased efforts on the sales front in 2016.

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