Hedge fund assets remained above $3 trillion to end 2016, despite large-scale redemptions that topped $100 billion for the full year.
2016 Hedge Fund Letters:
December was a fitting end to a difficult year for the industry. While the level of outflows during the month was on par with prior years (an average of $18 billion removed over the last five Decembers) it marked the sixth month of outflows in the last seven, and resulted in Q4 not only being the fifth consecutive quarter of redemptions, but also the largest quarterly outflow from the industry since Q1 2009, and the height of the financial crisis.
It’s clear a swath of investors are uncertain how to utilize the industry’s available talent. It’s also clear there are pockets within the industry where talented managers can find, and realize valuation anomalies. The quandary for the largest potential investors in 2017 is how best to find a role for the industry within its portfolios.
Highlights
- Investors redeemed an estimated $23.7 billion in December, and $43.2 billion in Q4 2016.
- For the full year 2016, investors removed a net $106.0 billion from the hedge fund industry.
- Redemptions from managed futures accelerated in December as the strategy disappointed investors in 2016.
- Investors’ allocations decisions in 2015 and 2016 proved to be unfortunate as winning strategies faced the largest redemptions and vice versa.
Redemptions Rise in December, Over $100b Out in 2016
Investors redeemed an estimated net $23.7 billion from hedge funds in December. For the full year 2016, investors removed a net $106.0 billion from the hedge fund industry.
Hedge fund assets ended 2016 at $3.042 trillion, an increase of $13.9 billion. Performance gains of $119.9 billion offset investor outflows. Redemptions in 2016 were the industry’s largest since 2009, and the third year on record where investors removed more than they allocated.
Flows Overview
- December was a fitting end to a difficult year for the industry. While the level of outflows in December was on par with prior years (an average of $18 billion removed over the last five Decembers) it marked the sixth month of outflows for hedge funds in the last seven, and resulted in Q4 not only being the fifth consecutive quarter of redemptions, but also the largest quarterly outflow from the industry since the Q1 2009 and the height of the financial crisis.
- Throughout 2016, investors clearly reacted to widespread underperformance from 2015, but at the same time showed a willingness to allocate to products which performed well. Nearly $180 billion was removed from underperforming products through 2016, while over $70 billion was allocated to those who were able to post gains.
- The biggest asset gainers of the year were managed futures products. Unfortunately, they also produced the worst average returns of any major strategy and December/Q4 redemptions reflect investors’ dissatisfaction. In the first nine months, investors added $20.0 billion into the strategy, but outflows emerged in October, and accelerated through December. After receiving the second largest allocations in 2015, and the largest in 2016, managed futures performance will likely be seen as the industry’s biggest disappointment of 2016.
- On the opposite side, event driven strategies lost more investor money than any other universe in 2016, and in 2015, but produced some of the industry’s best returns this year. If nothing else, the period of 2015/2016 may go down as one of the worst for investor allocation decisions on record.
- There was one fortunate decision investors made in 2016, which was to, in the face of a significant drawdown, allocate to commodity strategies. The allocation process began in mid-2015 when commodity funds were at the tail-end of a nineteen month drawdown. Commodity funds returned more than 6% in 2016.
- Distressed was another segment of the industry from which investors withdrew assets in both 2015 and 2016. All distressed funds did in 2016 in return were to be the best performing primary strategy of the year. Investors, however have indicated a strong interest in private debt products, which may either compete with distressed hedge funds for assets, or often be offered by the same managers in place of a hedge fund structure. In fairness, this is not an investor issue, but rather an issue of what the most appropriate approach to the best opportunities in the current market.
- After three years of being the most attractive universe in the hedge fund industry, multi-strategy funds’ large December outflows act as a question mark at the end of their first annual redemptions since 2012. The group endured poor performance at the turn of 20015/16, endured high profile fund closures due to elevated losses, and litigation against one of its largest constituents. Unlike event driven managers who produced some excellent returns in 2016, the multistrategy space has left investors facing a difficult allocation landscape. Historical track records, and transparency into internal strategy allocation process will likely be high on investors’ lists of demands before allocating back into this space.
- Macro funds may have also left investors scratching their heads, perhaps even more so had it not been for a fairly good Q4 by some larger products. In the end, the ten macro funds which lost the most investor money in 2016 gained an average of 6.5%, while those who gained the most new assets returned an average of 3.0%. For the three largest asset gainers, an average return of 11% in Q4 perhaps saved more than just their year.
Final Strategy Thoughts:
Investor flows for 2016 resembled an industry in crisis. They were similar to mid-2011 and 2012 in persistence, but dwarfed outflows seen during the European sovereign crisis in magnitude. They were below the levels seen during the aftermath of the great financial crisis, but have been much more persistent. It’s clear a swath of investors are uncertain how to best utilize the industry’s available talent. It’s also clear there are pockets within the industry, even at its seemingly most saturated point, where those talented at finding and realizing valuation anomalies, and those able to create sophisticated systematic processes, are still able to shine. The quandary for the largest investors is to find a role for this industry within portfolios. Does one treat it as a group that as whole is able to produce steady aggregate return streams with relatively low volatility, or should individual managers who excel in specific asset classes find a place alongside traditional managers, as a holistic approach to specific markets? What 2016 has shown us is there is talent in this industry, what 2017 will show us is how investors decide to take advantage of it.
EM Ends 2016 in a Positive Light, Q4 Flows Firmly Positive
Despite the presence of losses in China and the Middle East, investors dipped their toes back into emerging market hedge fund strategies in the second half of 2016.
Regional Flows Overview
- After a nineteen month span of negative investor sentiment toward emerging market hedge funds that lasted through January 2016, investors slowly started to return. Periodic elevated monthly outflows still occurred during the year, as well as negativity toward specific country exposures, but in the last five months, investors allocated an above average amount in all but one month.
- It appears the waves of negativity toward Chinafocused funds that persisted for most of the year have subsided. Flows were still negative in December for the universe, but only slightly so.
- European-domiciled hedge funds went through a period between early 2015 and early 2016 when they were in high demand from investors. A fair portion of the allocations went to the many high profile managed futures funds operating across Europe, but allocations were fairly widespread by strategy types. In May, investors did an about-face and assets began to march in the other direction. Since June, investors in European hedge funds have removed money each month, accelerating into the end of the year. Q4 flows were disproportionate large for the region’s AUM base compared to the U.S. or Asia. It is likely an unfortunate confluence of performance and regulatory concerns impacting the European hedge fund industry.
Article by eVestment
