Hedge Fund Reallocations Show Investors Balancing Risks

Hedge funds saw their first month of net outflows in December after five straight months of inflows, but with steady growth, especially for long/short equity strategies, it doesn’t look like people are moving out of hedge funds. Instead, the net outflows (and some sector specific inflows) look like a round of year-end asset reallocation that could give us a hint of what investors expect in 2014.

After five consecutive months of positive asset flows; during which the industry witnessed net allocations of $70.2 billion, the month of December saw a sharp detraction from this trend with investors withdrawing a net of $8.6 billion from the hedge fund industry. Meanwhile all regional mandates registered their fourth consecutive month of positive performance-based gains raking in $4.9 billion during the month.

North American hedge funds had the largest outflows

North America had both the best performance-based gains ($3.2 billion) and the largest net outflows ($11 billion) leaving net AUM down 0.58%, and Europe had the largest net inflows ($2.5 billion). Japan and Asia ex-Japan each had $200 million in net inflows, and Latin America had $500 million in outflows. Considering how bullish most analysts are on the US market, it might seem strange to pull money out of hedge funds with a North American mandate, but this could be an example of investors moving their risk from one asset class to another. If you’re going to increase your exposure to the US economy directly by buying stocks, it probably makes sense to decrease exposure to the same economy in hedge funds.

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Arbitrage had $5.3 billion net inflows in December

Arbitrage was easily the most popular strategy in December, with $5.3 billion in net inflows, followed by long/short equities ($1 billion net inflows) and event driven strategies ($200 million net inflows). Every other strategy saw net outflows; macro strategies in particular had $8 billion in outflows. Long/short equities continued to have the best performance, earning $3.5 billion, followed by event driven strategies ($500 million). All other strategies were close to flat for the month.

Long/short equity strategies accounted for nearly half of all hedge fund performance gains last year, and if the stock market continues to grow than they will likely remain the highest performing strategy. Seeing so many investors put their money into arbitrage, instead of long/short equities, is likely another indication that people are investing in equities themselves and want a different type of risk from hedge fund allocations.

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