Fund Of Hedge Funds – The Evolution Of Industry Assets by Preqin
Fund of Hedge Funds Outlook
In this month’s feature article, we take a look at the fund of hedge funds industry, examining the challenges faced in 2015, the evolution of industry assets and the outlook for the industry in 2016.
Overview of the Fund of Hedge Funds Sector
Fund of hedge funds were unable to sustain the growth witnessed in 2014 over the course of 2015. The industry’s assets under management (AUM) declined by $12bn over the year, wiping out over a third of the $33bn added in 2014. As at 31 December 2015, the fund of hedge funds sector managed $807bn in capital (Fig. 1). The sector experienced a wide range of activity over the year, from closures to mergers, acquisitions and spin-outs, as fund of hedge funds managers continued to search for solutions that meet the evolving needs and performance demands of institutional investors. In this article, we examine the changing fortunes of funds of hedge funds over recent years.
The Evolution of Industry Assets
The steady decline in fund of hedge funds assets, which began in 2008, was reversed in 2014. However, the sector once again saw outflows in 2015, with $12bn in capital lost over the course of the year. North America was the only region in which funds of hedge funds showed growth over the year, adding $9bn in new assets. In fact, North America-based fund of hedge funds managers have experienced year-on-year growth since 2011. In addition, a larger proportion (34%) of North America-based fund managers reported to Preqin that their AUM had increased over 2016 than those that reported declines in AUM (25%), as shown in Fig. 2.
In contrast to their North America-based counterparts, Europe-based fund of hedge funds managers experienced a tough year in 2015 as they recorded a further decline in assets, dropping $14bn to $183bn by December 2015. More Europe-based fund managers reported that their AUM had declined over 2015 than had increased. Europe-based managers have faced financial uncertainty surrounding the eurozone and regulatory challenges in the shape of the AIFMD. Managers in the region have dropped from a 44% share of multi-manager assets in 2007 to just 23% as at December 2015. The difficulties faced by funds of hedge funds in Europe in 2015 translated into a notable number of fund closures: 60% of the fund of hedge funds liquidations in 2015 were Europe-based vehicles (Fig. 3). The news was not all bad for Europe, however: multi-manager vehicles focused on Europe reported higher returns than vehicles focused on North America (Fig. 4).
Fund of hedge funds managers based in Asia-Pacific saw asset gains of $5bn in 2014 completely reversed, ending 2015 with $18bn in AUM. Despite this, there is some cause for optimism in the region; recent regulatory changes, particularly in China, have focused on reducing barriers to entry for overseas investors which may result in inflows in the future. In addition, the performance of funds of hedge funds focused on Asia-Pacific was superior to other regions, despite the threat of a slowing Chinese growth rate contributing to four consecutive months of losses (June-September). The Preqin Asia-Pacific Fund of Hedge Funds benchmark ended 2015 on 5.90%, above other regional benchmarks (Fig. 4).
Fund of hedge funds managers outside North America, Europe and Asia-Pacific are predominantly based in Brazil and South Africa. The combined AUM of funds of hedge funds in these two countries accounts for 78% of Rest of World capital.
Further growth in 2016 may be driven largely by performance. Institutional investors were asked at the end of 2015 about their plans for their fund of hedge funds investments in 2016 (Fig. 5). Forty percent of institutional investors use funds of hedge funds in their portfolio – of this group, a larger proportion plan to reduce their exposure to these funds than plan to increase. The largest proportion plan to maintain their fund of hedge funds exposure during 2016.
Fund of Hedge Funds Launches in 2015
With the level of capital invested in funds of hedge funds falling, fund managers saw little scope for new products to enter the market in 2015. As a result, just 32 new funds were incepted in 2015 (Fig. 6). Although the number of launches recorded for 2015 is likely to increase in the first half of 2016 as more data becomes available, it remains unlikely that this figure will surpass the number of launches (86) in 2014 or outstrip the number of liquidations in 2015, which stands at 97 and is also expected to grow.
The fact that there were more than three times as many fund closures as launches in 2015 confirms that the fund of hedge funds industry remains in a period of consolidation. There were a number of mergers, acquisitions and spin-outs in 2015, including Aberdeen Asset Management announcing the purchase of Arden Asset Management in Q3 2015, which was completed in January 2016, and Investcorp acquiring SSARIS Advisors in Q4 2015. A long period of growth prior to 2008 saw the fund of funds sector mature and institutional investors become more comfortable with hedge fund investments. The environment in recent years has become more competitive, as investors increasingly move towards single-manager portfolios, and many established players in the industry now seek to facilitate innovation by acquiring profitable fund of hedge funds businesses. By marketing new products and investment solutions, managers aim to diversify their offering and attract a wider group of investors.
A multi-strategy approach is sought by many fund of hedge funds investors; the majority (54%) of new funds that came to market in 2015 aim to provide strategy diversification (Fig. 7). Almost one-fifth of fund of hedge funds launches focus on equity strategies hedge funds and 12% primarily provide exposure to macro strategies funds. Perhaps encouraged by solid performance in recent years and possible opportunities in fixed income markets in 2016, credit-focused vehicles accounted for a larger proportion of new launches in 2015 (8%) than they did in 2014 (1%).
Funds of hedge funds experienced varying degrees of success in 2015 – a year in which many hedge fund managers struggled to navigate tricky macroeconomic environments. The industry saw a significant amount of consolidation, with overall assets declining slightly amid numerous fund closures, particularly in Europe. North America-based managers enhanced their market share and now control almost three-quarters of global fund of hedge funds assets. Despite this, Europe-focused funds outperformed those targeting North American opportunities for the first time since 2008. It will be interesting to see if this helps the European industry to stabilize in 2016, or whether the trend of fewer funds controlling smaller AUM will continue.