Put Into Perspective: Outlook For Hedge Funds ‘More Positive’ In 2016 by Skenderbeg Alternative Investments
“Better to preserve capital on the downside rather than outperform on the upside.” – William J. Lippman
Outlook for hedge funds ‘more positive’ in 2016
eVestment report expects industry growth to match or exceed 2015
This year has been a record-breaking year for initial public offerings with companies going public via SPAC mergers, direct listings and standard IPOS. At Techlive this week, Jack Cassel of Nasdaq and A.J. Murphy of Standard Industries joined Willem Marx of The Wall Street Journal and Barron's Group to talk about companies and trends in Read More
The hedge fund industry is in a good position for growth in 2016 and is set to outpace last year despite recent negativity. Estimated net asset inflows of $50-60bn in 2015 are anticipated to be either matched or improved upon, eVestment’s 2016 Hedge Fund Industry Out-look report suggests.
eVestment identifies increased interest in multi-strategy, macro and managed futures products and dampened interest in credit and event-driven funds as key factors in their assessment of the industry’s prospects. Multi-strategy fund inflows are expected to continue this year due to their diversity and return potential as demonstrated in 2015, in addition to an expected shift by investors towards alternatives in the year ahead, with the data provider tip-ping the strategy to attract up to $35bn.
Despite mixed macro fund performance in H2 of 2015, growth in this space is expected to be driven by an increase in demand for hedge fund products from institutional investors. Demand from institutional allocators is predicted to hold steady unless a major market event were to take place, when only the most defensive asset classes would gain new assets. However, increased institutional investment in the hedge fund space is expected to be less than that in the private equity or infrastructure space.
The eVestment report said this trend indicates “the institutional community continues to be willing to sacrifice liquidity for less-correlated sources that will help to meet target returns”.
Hedge fund workers without MBAs make bigger bonuses: SumZero
A post-graduate degree may not be the smartest investment for a young pro-fessional going into the hedge fund industry.
Hedge fund associates with undergraduate degrees bring home bigger paychecks than their peers with advanced business degrees, according to a survey conducted by SumZero, an online community of fund professionals.
Click here for the full compensation report.
So-called pre-MBA associates took home an average of $200,000, including a $90,000 bonus, according to SumZero’s 2016 Fund Compensation Report, which is based on a survey of more than 1,800 associate positions between 2012 and 2015. Associates with an MBA, meanwhile, took home an average of about $184,000, including a bonus of $60,000.
SumZero struggled to explain the results.
“It is unexpected to see the pre-MBA associates out-earning their peers,” said Nicholas Kapur, chief operating officer at SumZero. “There is a chance that those without MBAs have a greater incentive to perform because their roles are generally not permanent … Our best guess is that the pre-MBA pool might just be a bit more competitive.”
Hedge fund industry assets increase in difficult year, managers upbeat for 2016
Despite a challenging year, hedge fund industry assets under management increased by approximately $180 billion during 2015 and now stand at approximately $3.2 trillion, according to industry data provider Preqin. The findings were part of Preqin’s annual Global Hedge Fund Report, which was released this week at MFA’s 2016 Network conference in Miami.
According to the report, investors committed nearly $72 billion of new capital to the industry and Preqin’s benchmark reported 2.02 percent gains during the year. Even though performance was down from previous years, 37 percent of surveyed fund managers reported an increase in institutional capital.
Time for worried investors to start betting on hedge funds?
Money spent on the high fees that come with investing in hedge funds might seem to have been a waste over the last six years, considering the performance of traditional assets. But with the bull market in stocks now very long in the tooth and interest rates at historic lows, hedge funds are looking like an attractive alternative to investors worried about their portfolios.
“This market has been driven by the Fed since 2009, and the easy money has been made,” said Charles Gradante, managing principal of the Hennessee Group, an investment consultant focused on hedge fund research and manager selection. “Most people want to stay in equities, but they also want a more hedged investment management style.”
Hedge funds – Top 10 trends for 2016
- Reduction of expected returns for a diversified hedge fund portfolio. Hedge fund performance is driven by a combination of alpha (manager skill) and beta (market driven return). From 2009 to the beginning of last year, as both the fixed income and equity markets experienced strong bull markets, beta had been a tail wind for hedge fund performance that rewarded managers with net long market exposure. Over this time period, investors’ return expectations for new managers steadily declined from mid-teens back in 2009, to above 10% in 2014 and to mid-to-high single digits today. This reduction in expected returns stems mostly from the belief from many investors that beta will add very little value over the next few years due to the capital markets trading near all-time highs. This reduction of return expectations will have a broad impact throughout the hedge fund industry.
- Greater demand for hedge fund strategies with low correlations to long only benchmarks. Lower return expectations for hedge funds will dramatically change the relative demand for hedge fund strategies. Higher beta strategies will be perceived as higher (and unnecessary) risk. Some of the strategies that will see a significant increase in demand include: relative value fixed income, market neutral long/short equity, CTAs, direct lending, volatility arbitrage, reinsurance and global macro. These strategies will see an increase in demand due to their perceived ability to generate alpha regardless of market direction and as a hedge against a potential market sell-off.
- Hedge fund industry assets to reach all time high in 2016. Despite all the negative stories about the industry, including some recent high profile fund closures, total hedge fund industry assets will reach a new all-time high in 2016. This will be fueled by investors led by pension funds reallocating assets out of long only fixed income to enhance forward looking return assumptions and other investors shifting some assets away from long-only equities to hedge against a potential market sell-off. We expect hedge fund industry assets to rise by $210 billion, or 7%, which was derived from a forecast of a 2% increase due to net positive asset flows and a 5% increase from performance.
- Smaller managers will outperform. While many studies have shown stronger performance by younger and smaller funds, the 2016 landscape should provide a particularly attractive environment for smaller hedge funds. In moving to a performance environment increasingly dependent on alpha, security selection becomes even more important, especially in less efficient markets where smaller man-agers have a distinct advantage. Since 2009 there has been a high concentration of hedge fund investment flows to the largest manag-ers with the strongest brands. This has caused many of these managers’ assets to swell well past the optimal asset level to maximize returns for their investors. As they become larger, it is increasingly difficult for large, multi-billion dollar funds to add value through se-curity selection. Additionally, large fund managers are often stewards of capital for many large pension clients and thought of as ‘safe hands’ by risk adverse investment committees. They have an incentive to reduce risk in their portfolio in order to maintain assets and thereby increase the probability of continuing to collect large management fees.
- Pension funds reducing the average size of managers to whom they allocate. As pensions struggle to enhance returns to meet their actuarial assumptions, we will also see an increase in the speed of the evolution of pension funds’ hedge fund investment process. Historically, many pension plans started with an investment in hedge fund of funds, followed by hiring a hedge fund consultant and invest-ing directly in, typically, the largest hedge funds with the strongest brands. As they increased their knowledge of the hedge fund indus-try and added to their internal research teams, they began making more independent decisions and focused on “alpha generators” which included mid-sized managers. Finally, they evolved into the “endowment fund model” or best-of-breed strategy of investing. In the final stage, hedge funds are no longer considered a separate asset class, but are incorporated throughout the pension fund’s portfo-lio. Five years ago a hedge fund typically needed multiple billion in AUM to be considered by pension funds, while today we estimate this has declined to $750 million and expected to go lower over time. This will have a very positive impact on the hedge fund industry.
- High quality marketing is essential for asset growth. The hedge fund industry is highly competitive with our estimate of over 15,000 hedge funds in the market place. In 2016, we will have continued concentration of hedge fund flows into a small percentage of managers. We expect 5% of funds to attract 80% to 90% of net assets within the industry. In order to succeed it is not enough to have a high quality product offering with a strong track record. Performance ranking among the top 10% of hedge funds puts a manager in an exclusive group of 1,500 funds. Hedge funds with high quality product offerings must also have a best-in-breed sales and marketing strategy that deeply penetrates the market and builds a high quality brand. This requires a team of well-seasoned professionals that will project a positive image of the firm. This can be achieved by either building out an internal sales team, leveraging a leading third party marketing firm, or a combination of both. Firms that do not have a high quality sales and marketing strategy will have a difficult time raising assets.
- Increased hedge fund marketing activity outside the US. Marketing activity outside of the US has declined significantly over the past few years due to AIFMD requirements becoming effective within the Euro-zone. This has increased the focus on marketing to US investors by a growing number of US domiciled hedge funds (with a majority of hedge funds already located in the US) which has caused the US market place to become increasingly more competitive. Additionally, many non-US firms aggressively target the US market. We be-lieve this trend will reverse as managers begin to realize that hedge fund investors outside the US are significantly less covered and the fact that the registration burden of selling in many non-US countries is less complex than perceived. In addition, a large segment of European based investors tend to be more willing to invest in smaller managers due to their higher return potential.
- Continued pressure on fees. The hedge fund industry is seeing pressure on hedge fund fees from many fronts. Large institutional investors are successfully negotiating large fee reductions from standard fees for large mandates and this pressure is expected to increase as large institutions represent a larger percentage of the market. Small hedge funds (generally those under one hundred million in aum) more frequently have to offer a founders’ share class with a 25% to 50% discount to standard hedge fund fees as an incentive to invest in their fund. This ‘small fund’ threshold is trending toward $200 million. While profit margins on UCITS structures are already below those for traditional hedge funds, fee pressure is also intense in other fund structures including managed accounts and 40 Act funds.
- More hedge funds shutting down. Hedge funds will shut down at an increased pace driven by four factors: 1) the current number of hedge funds is near an all-time high of 15,000. Given a consistent rate for hedge funds ceasing operations, hedge fund closures should also be at an all-time high. 2) This increase in the number of hedge fund managers has reduced the average quality of hedge funds in the industry. Many of the lower quality managers will experience a higher rate of closing down, which is good for the industry. 3) Increased volatility in the capital markets increases the divergence in overall return between good and bad managers. This in turn increases the turnover of managers, as bad managers get fired and money is reallocated to those who outperform. 4) The competitive landscape for small and mid-size managers is becoming increasingly difficult. They are being squeezed from both the expense and revenue side of their businesses. As discussed earlier in this article, having a superior quality product alone is not enough to generate inflows of capital. As a result, we expect the closure rate to rise for small and mid-sized hedge funds.
- Blurring of the lines between hedge funds and private equity funds. Back in 2008, the main difference between hedge funds and private equity funds was the structure of the fund and often not the liquidity of the underlying investments. This was especially the case with illiquid fixed income instruments where many hedge funds that focused on these strategies offered monthly liquidity. This created significant liquidity mismatches for many hedge funds which caused them to impose gates, suspend redemptions, or liquidate their fund. Today many sophisticated investors understand the benefits of illiquid investments, but are demanding fund liquidity provisions that match the underlying liquidity of the portfolio. We will see longer lock-ups, longer redemption notice periods, gates and private equity structures for illiquid strategies.
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