Hedge Funds 1H16 Round-Up: Winners And Losers by Preqin
A Continued Desire For Transparency
by Todd Moyer Executive Vice President, Global Business Development, Confluence
Can you tell us briefly about Confluence?
Confluence was founded in 1991 as a performance reporting application for ’40 Act mutual funds. Since then we have evolved to become a global platform that consolidates and manages data for all types of asset managers, enabling them to meet regulatory and investor demands for increased transparency. Today, eight of the top 10 global asset managers and seven of the top 10 global service providers rely on Confluence to meet these reporting and data management requirements.
We continue to focus and grow our core areas of expertise: performance and analytics reporting, regulatory reporting, expense management and what we call “investor communications”, which is financial reporting, prospectuses, factsheets and a variety of communications and reports that are required at the investor level. To put it simply, we help our clients consolidate their fund data into a single platform, validate its accuracy and then leverage that data for multiple outputs and purposes. Our goal is to improve operational efficiencies and performance for our clients.
Our vision is to be the prominent global leader in data-driven solutions that enable asset managers to meet their regulatory and investor reporting needs using a single platform. A big part of our focus when developing solutions is to ensure that what we are developing will enable clients to remain nimble and proactive in the current market environment.
How have you seen regulation change the hedge fund sector in recent years? How has this increased need for transparency across all types of fund structures changed the way data is managed by fund companies and administrators?
Over the past four years, reporting has gone from very minimal to relatively significant within the alternative fund and hedge fund space. This has been largely driven by regulatory focus on managing systemic risk, and we do not see that trend slowing. Reporting has been the way that hedge fund managers comply with valuations, derivatives and disclosures in addition to handling recent regulatory changes, such as Form PF in North America as well as Annex 4 and AIFMD reporting throughout Europe. Commodity pool managers must also comply with Form CPO-PQR.
Although it has been a very busy last several years in terms of regulation, I think every indication is that there is going to be a continued desire for transparency. And that is really what we are talking about here; whether it is fee transparency or whether it is underlying risk or investment transparency, we feel the global regulators will have a continued desire and effort to focus on that.
Because of these regulatory changes, there has been a fundamental shift since the financial crisis in the way that firms are required to manage data. We are at a tipping point where asset managers’ abilities to effectively manage the volume and the complexity of the data through their current systems have forced the need to evaluate how to better handle that data. We think that the way firms embrace technology to assist in managing their business data will separate the winners and losers.
One of the terms that we are hearing over and over now is “Regulatory Technology” or “RegTech,” which is all about how firms will leverage technology to manage data and meet the challenges that regulatory agencies are putting on them globally. So what we have seen escalating since the financial crisis is the need to embrace RegTech.
Have you seen any changes in the hedge fund sector and investor base?
There has been quite a bit of change in the last several years. Hedge funds are now attracting institutional and retail investors, and investors and regulators are both focused on high levels of efficiency and accuracy – all resulting in heightened data management challenges.
We have also seen a convergence of fund investment strategies. With that convergence, today’s hedge fund managers are increasingly managing “mutual fund-like” products. As a result, retail investors are expecting them to administer their funds with mutual fund-like efficiency, accuracy and reporting frequency.
We have also seen that transparency is a high priority. We believe the firms that embrace transparency – both from the regulatory side of things and also from the investor’s point of view – are going to be the most successful in attracting assets over the long term. Overriding all of this is cost, which has taken on heightened importance as a driving component of investment decisions. We expect to see how asset managers manage cost – as well the overall expense ratio and cost of the investment to the end investor – as critical factors impacting investment decisions moving forward.
How can companies such as Confluence help with the challenges arising as a result of regulatory and other changes to the hedge fund sector in recent years?
Confluence has been in the data management business for over 25 years. We work with some of the largest asset managers throughout the globe. With the rapid changes in terms of regulation, transparency and reporting over recent years, there has been an urgency to react and asset managers have come to us for the solution. Over the past two years we have looked at the way that Confluence leverages technology – the latest and greatest in data management – to enable us to meet this ever-changing need for data management and data re-use. We also have the ability to speed the market to meet the demands we are seeing.
As a result, we recently introduced to the market our Unity NXT™ Regulatory Reporting platform, which was built to provide a complete solution for regulatory data integration, aggregation, reporting and reusability for the asset management industry. With our new regulatory reporting platform, we have built a technology solution to meet new client demands leveraging much of the data that already sits within the Unity® platform – our core platform.
If you look at most regulations, much of the data that asset managers must now report is consistent with the type of data that Confluence has been aggregating and managing for over 25 years. That puts us in a very strong position to help clients meet these new requirements. In many cases, we have already sourced up to 70% of the data needed to meet a specific regulatory reporting obligation for our clients. Another key differentiator for Confluence is that our solution does not require long development cycles. The platform was founded on the idea that regulation is constantly changing, so we have designed it to be easily deployed with the ability to quickly add new functionality. It is also important to note that we did not build this platform off of legacy technology. We are looking at and handling data much differently than we have in the past.
This is something that Confluence has made a significant investment into in order to serve the market needs, and we will continue to drive ahead of the fast pace of regulatory change. So we believe that not only are we in the right position today, but we are confident that we will remain well positioned because our solution was built to help us, and our clients, stay ahead of regulations, which is key.
For example, we launched our new regulatory platform less than a month ago and already we are working with one of the largest global fund service providers to help meet their needs following the introduction of a new regulation in Luxembourg that is set to go live at the end of June called U1.1. The challenge for the service provider was that it was very difficult to react with the technology they had in place and meet the regulatory deadline. They came to Confluence and within a matter of weeks we were able to produce the capability they required by leveraging our new regulatory reporting solutions and data already available within our Unity platform.
We were able to go live before the end of June, something that would have been a significant challenge for that organization using the technology they had in place. We are really excited about the ability to not only leverage our core platform, but to add additional capabilities with our new data management platform in order to meet the needs of our existing hedge fund client base as well as new customers.
The challenge of data management is at the center of the operational change imperative in the hedge fund industry. With financial reports and regulatory systemic risk reports sharing roughly two-thirds of the same data, capturing data in a single location and streamlining and automating data validation and report creation is now, and will increasingly be, key to ensuring both efficiency and accuracy in reporting.
Hedge Funds – H1 2016 Round-Up: Winners and Losers
Macro strategies delivered favorable returns at the start of 2016, which have continued into Q2, and ended the quarter as the top performing hedge fund strategy, and also at the top of the league table for 2016 YTD.
The strategy generated a return of 1.62% over Q2. Despite May returns ending a four-month positive streak, macro strategies have delivered 3.18% in 2016 so far, significantly exceeding the 1.36% returned by the Preqin All-Strategies Hedge Fund benchmark. The performance has not gone unnoticed by institutional investors: macro is the second most targeted hedge fund strategy over the next 12 months.
2016 has so far marked a turnaround in the fortunes of emerging markets. Preqin’s Emerging Markets Hedge Fund benchmark was the top performing regional benchmark in Q2 2016 and has returned 4.17% so far this year.
Latin America-focused funds had a strong first half of the year, generating 11.63%, with Brazil focused funds posting an impressive 12.94% for 2016 YTD.
Russia & Eastern Europe has also experienced strong performance in 2016 YTD (+7.67%) as a result of the strengthening Russian rouble and rising oil prices.
Europe-focused hedge funds have produced lower returns than other regional funds so far this year at -2.38%, compared with 1.75% returned for North America-focused funds.
After three consecutive months of positive returns, the result of the UK’s referendum on EU membership created challenging market conditions, with Europe-focused funds losing 1.47% in June, bringing the full Q2 returns to -0.12%, compared to the 2.15% generated by the Preqin All-Strategies Hedge Fund benchmark.
Funds of Hedge Funds
Funds of hedge funds had a poor start to the year in terms of performance, returning -2.40% for January, the strategy’s lowest monthly total since October 2008. Further negative performance in April (-0.17%) contributed to a Q2 return of 0.07%. So far in 2016, funds of hedge funds have lost 2.95%, compared with gains of 1.36% for the Preqin All-Strategies Hedge Fund benchmark.
Funds of hedge funds’ poor performance has resulted in low appetite for the structure among institutional investors. Only 12% of investors have issued searches for commingled funds of hedge funds in the next 12 months, almost half the proportion seen in Q1 2016.
Performance Update: Q2 2016
Q2 2016 saw a return to positive territory for hedge funds, with the Preqin All-Strategies Hedge Fund benchmark returning 2.15% for the quarter (Fig. 1), compared with -0.78% for Q1, as shown in Fig. 2. Despite a challenging start to the year, June marked the benchmark’s fourth consecutive month of positive returns. CTAs appeared to be on track for a disappointing Q2; however, the benchmark generated 2.72% in June – the structure’s highest monthly return since January 2015. This gain brings CTAs’ year-to-date figure up to 3.27%, significantly outperforming the Preqin All-Strategies Hedge Fund benchmark (+1.36%).
Despite producing negative returns in both January and February, credit strategies generated the second highest returns of Q2 2016 (+2.39%, Fig. 3). Event driven strategies had the weakest performance in June (-0.50%), although the strategy had generated the highest returns in April and second highest returns in May, finishing the quarter on 2.21%.
As illustrated in Fig. 4, emerging markets-focused hedge funds have generated the highest returns in Q2 (+3.66%). This year has marked a turnaround in the fortunes of funds focused on these markets, driven by political optimism and rising commodity prices during Q2 2016. In 2016 so far, Latin America-focused funds have generated 11.63% (for more information, please see page 5: ‘Winners and Losers’). Brexit has had a negative impact on the performance of Europe-focused hedge funds, which generated -1.28% for June, the only region to finish the quarter with a negative return (-0.12%).
All hedge fund strategies generated positive returns in Q2, with equity strategies delivering the strongest cumulative performance (+2.43%, Fig. 5). Credit strategies delivered the second highest return over the quarter (+2.39%).
As shown in Fig. 6, the 12-month rolling return of hedge funds (-0.93%) remained lower than that of the S&P 500 Index (+1.73%).
The correlation of CTAs to the S&P 500 has fallen since a spike at the end of 2016 (Fig. 7), and the rolling three-year correlation is now close to zero.
Performance Benchmarks: Q2 2016
Hedge Fund Launches in Q2 2016
Single-manager hedge funds represented 71% of hedge fund launches in Q2 2016, a three percentage point decrease from the previous quarter (Fig. 1). Despite favorable returns in Q1 2016, CTAs represented just 3% of Q2 launches. Liquid alternatives saw an increase in launches compared to Q1 (up from 15% to 19%) with UCITS funds representing 18% of all launches in Q2, the largest quarterly proportion of UCITS launches tracked by Preqin since the implementation of the directive. UCITS-compliant funds can act as a way for non- European AIFMs to raise capital from Europe-based investors; US-based fund managers account for approximately one-fifth of UCITS launches in Q2.
North America-based funds comprised the majority (66%) of launches in the second quarter of the year (Fig. 2); however, there has been an increase in Europe-based managers launching new vehicles: Europe-based firms accounted for 28% of all launches in Q2 2016 (up from 23% in Q1). Asia-Pacific- and Rest of World-based managers each represented 3% of fund launches.
Fifty-three percent of new funds launched deployed equity strategies, up from 40% in Q1, while credit launches comprised 18%, nearly double the proportion in Q1 (10%, Fig. 3). Correspondingly, the proportion of multi-strategy vehicles launched declined significantly from 19% in Q1 to 6% in Q2, and event driven launches declined from 13% to 6% in the same period.
Economic uncertainty following a UK vote to leave the EU has created potential opportunities for hedge fund managers; Europe-focused funds saw the largest proportional increase in their share of overall fund launches, increasing from 1% in Q1 to 16% in Q2 (Fig. 4). A greater proportion (21%) of newly launched hedge funds are focused on North American markets, while global-focused strategies’ share decreased substantially from 81% to just 49% in Q2 2016.
Largest Hedge Fund and Fund of Hedge Funds Mangers
Fund Searches Initiated in Q2 2016
The second quarter of 2016 saw 120 new fund searches added to Preqin’s Hedge Fund Online. Geographically, the proportion of fund searches has remained similar to results seen in Q1 2016, although there was slight growth in the proportion of fund searches issued by hedge fund investors outside North America, Europe and Asia-Pacific, increasing from 5% of fund searches in Q1 2016 to 8% in Q2 2016 (Fig. 1). Hedge fund investors in the more developed markets of North America and Europe continue to represent the vast majority (85%) of fund searches issued during the quarter.
Long/short equity strategies funds continue to be the most sought-after strategy among hedge fund investors: 56% of searches issued in Q2 target long/short equity, up from 48% in Q1 2016 (Fig. 2). This follows the results seen in Preqin’s 2016 Global Hedge Fund Report, when 79% of surveyed investors planned to either increase or maintain their exposure to equity strategies in 2016. Macro is included in almost a third (31%) of searches, while long/short credit and managed futures/CTA strategies experienced the largest growth in appetite, increasing by 11 and 12 percentage points respectively from Q1 to Q2 2016. The growing appetite for managed futures/CTA strategies may reflect an investor community that forecasts increasing volatility in public markets from macroeconomic events over the coming months.
Eighty-four percent of investors are seeking commingled single-manager hedge funds over the next 12 months, while only 12% of mandates include commingled funds of hedge funds (Fig. 3). Searches for UCITS vehicles, the second most preferred structure, have increased from 16% in Q1 2016 to 22% in Q2. The proportion of investors targeting single-fund managed accounts has remained relatively stable at 13% of all fund searches.
Fund of hedge funds managers issued the largest proportion (18%) of fund searches in Q2 2016 (Fig. 4). Wealth managers and private sector pension funds are also searching for hedge funds in significant numbers, accounting for 17% and 12% of all hedge fund searches in Q2 2016 respectively.
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