After the industry endured its most difficult period of redemption pressure in 2016 since the end of the financial crisis, we have been eager to see what kind of sentiment investors would bring to their hedge fund allocations in 2017. Despite flows being negative in January, the level of redemptions does not appear concerning. Outflows were centralized within products which underperformed in 2016, and there were many positive metrics at the fund level.
2016 Hedge Fund Letters
Prior year performance was a major negative overhang on the industry in 2016. With the vast majority of products producing positive returns in 2016, particularly in the second half of the year, that weight will have mostly been removed. Early flows into macro strategies is a prime example that investors appear willing to reallocate to the industry, particularly in the face of increasingly wary equity and fixed income markets.
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- Investors redeemed an estimated $5.2 billion in January 2017, far below the $19.3 billion removed in January 2016.
- Macro and commodity funds both began 2017 with positive investor sentiment.
- Losses throughout 2016 within larger managed futures funds continued to weigh on flows into the new year.
- Event driven and fixed income/credit flows were negative to begin the year, but H2 2016 returns may shift sentiment to positive.
Despite Outflows, 2017 Much Improved Start vs. 2016
Investors redeemed an estimated net $5.2 billion from hedge funds in January 2017. Total industry AUM sits at $3.033 trillion.
Hedge funds had their fifth consecutive monthly outflows in January, the longest streak since six months of outflows ending December 2011. Outflows were primarily from funds underperforming in 2016. The level was far below January 2016, and in-line with January 2015. The industry gained $44.1 billion of new assets in 2015.
- After the industry endured its most difficult period of redemption pressure in 2016 since the end of the financial crisis, the early months of 2017 will give a good indication of sentiment we should expect for the year. Despite flows being negative, the level of redemptions is not concerning, and far, far, better than the industry’s start last year when investors removed $19.3 billion in January 2016.
- Within the aggregate numbers we see positive signs at the fund-level. For example, 49% of managers had inflows during the month, solidly above the prior 12- month average. Over 17% of all funds and over 20% of large funds had meaningful inflows (>2% of AUM), both also well above their prior 12-month averages. Lastly, redemptions were noticeably focused within strategies that lost money in 2016. This is a good omen for 2017 because if only 30% of the industry was negative last year, and the main driver for outflows is poor performance, then one major negative influence does not have enough depth to be sustained.
- The largest redemptions in January were from managed futures funds, though fewer than half of products had outflows. Investors continue to display dissatisfaction with large products which underperformed in 2016. The ten funds with the largest redemptions have an average AUM over $4 billion, and average 2016 returns of -5.1%, while the ten with the largest inflows had an average AUM of around $900 million, and returned an average of +3.1% last year.
- Commodity managers had the lowest proportion of managers with outflows to start the year. The segment was one of the few with inflows in 2016, so January’s allocations are a good sign for the new year.
- While traditional US fixed income strategies have seen a recent influx of new assets (see eVestment’s traditional asset flows report), fixed income/credit hedge funds, outside of distressed, have had difficulty attracting net new assets. This a trend dating back to mid-2015, the end of the US Fed’s QE3 monetary policy, and subsequent extended performance drawdown caused by seven consecutive months of losses among larger funds. Since the second half of 2016, however, performance has been consistently positive across many funds. While there may be an overhang of negative sentiment, it would not be surprising to see that shift to positive this year.
- Event driven funds appear to be suffering a similar sentiment overhang as credit strategies. However, a significant shift to performance gains in H2 2016 may work in this universe’s favor as well. The event driven funds with the largest outflows in January (all except one of which had net outflows for all of 2016) returned an average of -0.6% in H1 and +7.6% in H2 2016.
- After seven consecutive months of redemptions, and a sixteen month span with only three monthly inflows and $21 billion removed, macro hedge funds started 2017 with a firm breeze of positive investor sentiment at their backs. While macro strategies have been seemingly maligned by poor returns, the ten largest reporting products returned an average near 7% in 2016. Yes, the segment produced its share unfortunate high profile performers in the last two years, but the wide distribution of returns has masked the fact there are many high profile gems.
- Multi-strategy hedge funds have been a good indicator for the industry’s flows over the last several years. The group had significant inflows in 2013-2015, as did the overall industry. A shift of sentiment against a backdrop of poor returns in H2 2015 and early 2016 brought an onslaught of outflows in H2 2016. Returns in H2 2016 were generally very good particularly among larger funds, and allocations to begin 2017 are a positive sign for the strategy and the industry overall.
Final Strategy Thoughts:
2016 was a difficult year for the industry, however the year has passed and there’s no need belaboring the point. eVestment’s outlook for 2017 flows hinges on two main influences;
1) The wave, or lack thereof, of inflows from institutional portfolios as a result of portfolio shifts in exposure to hedge funds. This had been a primary driver of inflows in 2013-2015, and faded in 2016.
2) The impact of prior year’s performance on the withdrawal, allocation, or redistribution of assets around the industry.
2016’s negative environment was the result of #1 being near flat, and prior year (2015) returns being negative. While it is not clear for 2017 if influence #1 will shift to positive, it is clear that influence #2 is nowhere near as negative as it was in 2016.
EM Investors Continue Two Step Forward, One Step Back Approach
Regional Flows Overview
- After nineteen months of nearly consistent redemption pressures facing emerging markets hedge funds ending January 2016, in the last twelve months, monthly allocations have shifted between positive and negative seven times. Since August 2016, flows have been positive, but any time the semblance of a trend has emerged, it has been cut short. Such was the case in January when redemption pressures ended the two month string of inflows to end 2016.
- The heaviest outflows from EM during the month were not focused on any particular regional exposure or strategy. The five products with the largest redemptions (accounting for 75% of reported outflows) accounted for four different strategies, and four different regional/country influences.
- China fund flows were slightly negative, however the negative influence was highly centralized to a small number of products, and particularly within one which under-performed its peers in H2 2016.
- Europe-domiciled fund flows were negative again in January for a ninth consecutive month, though far below levels experienced during that span. Over half of the reported outflows from European funds came from managed futures and macro products, though the majority of the negativity was from the managed futures space.
Article by eVestment