The hedge fund industry is facing a difficult time. Q3 2016 flows were the industry’s fourth consecutive quarterly outflow, and monthly data, including redemptions in September, does not show many positive themes. Unlike prior periods of elevated redemption pressures, public financial markets are not clearly operating as if we are in the midst of, nor exiting a crisis period. This means the current flow trends are more emblematic of an industry in crisis.
[drizzle]For every highlight, one could find a flaw. Managed futures are experiencing a good run of inflows, but recent returns may cause that to stall. Commodities have been favored, but outflows returned in September. Even the industry’s best performing segments, distressed and event driven, continue to be beset by redemptions. Now is a time when the industry must save itself, whether through transformation of structure or delivering returns, but more likely by a combination of both.
Redemptions Resumed in September, Q3 Ends as 4th Consecutive Quarter of Outflows
Investors redeemed an estimated net $10.3 billion from hedge funds in September, resulting in Q3 2016 net outflows of $29.2 billion. September’s outflow was the eighth month of negative sentiment since redemption pressures began to overwhelm the industry just over one year ago. Despite positive performance lifting overall AUM, Q3 was the fourth consecutive quarter of net investor outflows, matching the duration of redemption pressures brought about by the financial crisis.
- After a respite in August, it is difficult to find the bright spots amid September industry flows figures. Once again, the majority of products experienced outflows (55%), an elevated number of large funds experienced redemptions of greater than 2% of AUM (25%), and only one major strategy was able to record net inflows in Q3 (managed futures).
- The level of industry redemptions in Q3 were the largest of this current four-quarter outflow trend, and largest since Q1 2009. However, to put current redemptions in perspective, the cumulative outflow in the last twelve months of $86.7 billion is less than half the level amount in just Q1 2009, which was not even the largest redemption quarter in the financial crisis. The difference, however, is that public financial markets are generally not operating as if we are in the midst of a crisis period, which means the current flow trends are more emblematic of an industry in crisis.
- What would appear to be one of the few bright spots within the industry, managed futures funds experienced their fourth consecutive monthly inflow in September. Q3 net inflows of $6.4 billion were the only primary strategy where investors allocated with any commitment. However, there are seeds of discord from investors within the universe as twice as many funds experienced outflows vs. inflows in September and the universe has produced asset-weighted performance declines in five of the last seven months.
- After two consecutive monthly performance declines, commodity funds experienced their largest monthly investor outflow since March 2015. If one were to only look at quarterly figures, one would miss this nearterm influence of performance on commodity fund investor sentiment. While performance did rebound in September, the month’s redemptions were a first sign that investors are highly aware of how much has been allocated during the universe’s revival ($13 billion), and how long performance was dismal prior (~20 months).
- Two strategies outperforming the rest of the industry in 2016, distressed (+7.99%) and event driven (+6.23%), both continue to be overwhelmed by negative investor sentiment. The universes’ plight illustrates some core issues facing the hedge fund industry right now. Distressed hedge fund managers have been facing redemption pressures for nearly two years, however private credit products, whose liquidity profiles generally aligns them more with private equity than hedge funds, have been in demand. This highlights a structural issue with hedge fund vehicles rather than with demand for a specific manager skillset. While there appears to be demand for distressed and special situation investing, it is focused toward private markets and with the acceptance of longer commitments.
- Macro fund flows were positive in September, ending a three-month string of outflows. The current negative sentiment toward macro funds dates back a year, to September 2015, caused by a large monthly loss in June and August 2015. Since then, investors have redeemed an estimated $17 billion from the universe.
- Here we can highlight another general issue facing the hedge fund industry, as embodied by the macro universe; it is one of many intelligent people facing a very unique set of global macro-economic influences, and arriving at different opinions as to how these factors will effect absolute and relative valuations across markets. The result has been wide dispersions of returns, and investors who are left feeling a risk must be taken to accept one very intelligent point of view over that of another. The net result, prior to September at least, has been to symbolically select neither.
- After an aggregate nine-month drawdown of nearly 3% ending in February 2016, large multi-strategy managers have returned nearly 5%. Unfortunately, that came at a time when hedge fund investors seemed to be looking for reasons to exit. Elevated redemptions followed with outflows of $12.1 billion in June and July, but the flow of investors seems to have reached an equilibrium in the last two months. In a sense, it feels as though the fate of the industry is balanced on the back of this universe. It encapsulates the issues facing each universe, but it’s structure may allow it to overcome each. It has the ability to employ those whose points of view have been successful, and to not be hindered by structural issues facing individual funds. Q4 may bear the weight of sentiment past, and we may not truly see the fate of the industry until Q1 2017. Until then, performance has likely never been more critical to the hedge fund industry.
Emerging Markets See Largest Inflows in 17 Months
Emerging market hedge funds are quietly experiencing glimmers of positive investor sentiment. Country specific sentiment still appears mixed at best, but September inflows may signal a shift of negative sentiment which has persisted since mid-2014
Regional Flows Overview
- The string of negative investor sentiment toward EM products began in July 2014 and persisted through the strong US dollar run which hurt major EM exposures of Brazil, which then carried over into China. There were two spans of strongly negative sentiment, from July 2014 to March 2015, then from July 2015 through January 2016. This second stretch has dissipated less cleanly than the first, which is why the current positive investor sentiment feels similar to how investors turned around on commodity exposures. The relation between EM and commodities is not lost here, but it is always tenuous to call a shift in sentiment. Net flows in each of the last four quarters have been negative, but decreasingly so, and monthly information illustrates investors are returning.
- Investor flows for China-focused funds was very slightly positive among reporting funds in September. This is potentially significant as negative