This month’s edition of Hedge Fund Spotlight highlights the opportunities and challenges facing managers of hedge funds this year, including:
2016 Hedge Fund Letters
- AUM and performance expectations for 2017.
- Key drivers of change in the industry and the impact of global events.
- The challenging fundraising environment.
- Planned fund launches this year.
Hedge Fund Manager Outlook For 2017
Using the results of Preqin’s survey of over 270 hedge fund managers for the 2017 Preqin Global Hedge Fund Report, we look at what 2017 holds for managers in the industry.
Following a year which saw hedge funds post their highest return since 2013, as well as high-profile investors withdrawing from the asset class, Preqin surveyed over 270 hedge fund managers in November 2016 to find out their views on how events in 2016 affected their portfolios and their plans for addressing investors’ current sentiment towards the asset class.
Value Partners Asia ex-Japan Equity Fund has delivered a 60.7% return since its inception three years ago. In comparison, the MSCI All Counties Asia (ex-Japan) index has returned just 34% over the same period. The fund, which targets what it calls the best-in-class companies in "growth-like" areas of the market, such as information technology and Read More
Fundraising Difficulties In 2016
As reported in the 2016 Preqin Global Hedge Fund Report, nearly a third (32%) of investors planned to deploy less capital in hedge funds in 2016 than in 2015, compared with 25% that planned to invest more capital. This investor sentiment looks to have impacted fundraising in 2016, as nearly half (47%) of fund managers surveyed for the 2017 Preqin Global Hedge Fund Report experienced a more challenging fundraising environment over the past year (Fig. 1). However, the fundraising challenges varied by region. In Europe, approximately equal proportions found it less challenging (36%) as found it more challenging (39%). In contrast, in North America, half of all fund managers found fundraising more challenging and just 28% found it easier than in 2015.
In addition, 36% of all respondents believe it was harder to retain assets in 2016 compared to 2015 as investors continued to evaluate their hedge fund allocations.
Industry AUM Expected To Grow
In the face of a more challenging fundraising environment, fund managers remain upbeat: 40% of survey respondents believe hedge fund industry assets will increase over the course of 2017 (Fig. 2). Europe-based managers are particularly bullish on the outlook for fundraising in 2017: over half (52%) believe industry AUM will grow over the year.
While addressing investor concerns around performance and fees will be a key challenge in the year ahead, fund managers will look to build on the improved performance of the past 12 months and make 2017 a year in which to revive investor sentiment.
Major Challenges For 2017
By a significant margin, fund managers surveyed in November 2016 view performance (73%) and investor demand for more favourable fees (64%) as the leading challenges facing the hedge fund industry in 2017, issues that have become more prominent since Preqin’s survey in November 2015 (Fig. 3). While industry performance has improved over the past 12 months, fund managers will want this improvement to continue as we move into 2017.
Global Events Impact Performance In 2016
The Preqin All-Strategies Hedge Fund benchmark posted 7.34% in 2016, its highest annual return since 2013 (+12.47%) and more than trebling the gains of 2015 (+2.14%). However, the Preqin All-Strategies Hedge Fund benchmark still lagged the S&P 500 PR (+9.54%) by two percentage points.
Markets around the world witnessed volatility in 2016: the GB pound hit a 31-year low against the US dollar following the Brexit vote, oil prices surged as OPEC and non-OPEC states agreed to restrict output and US stock markets reached record highs following President Trump’s election. However, as seen in Fig. 4, fund managers around the world saw different events impact their performance in different ways.
The greatest proportion of respondents located in North America (41%) reported that the US election had the most significant positive effect on performance, perhaps driven by US stock markets reaching record highs in late 2016. Thirtyfive percent of Europe-based managers also saw the US election positively impact their performance, again the largest proportion; however, a significant 33% of Europe-based managers reported that they were negatively affected by this event, highlighting the various effects of the US election on global markets. Crowding of trades had the most significant negative impact on performance for the largest proportion (34%) of North America-based respondents, while 38% of Europe-based fund managers reported that the Brexit vote had a negative impact on their performance. Interestingly, fund managers based in Asia & Rest of World had a split opinion on the effect of US interest rate policy, with significant proportions reporting their performance was affected positively (41%) and negatively (32%) by this event.
Improved Performance Expected Over 2017
With the 2016 Preqin All-Strategies Hedge Fund benchmark (+7.34%) outperforming the 2015 benchmark (+2.14%), Preqin asked respondents for their expectations of performance in 2017 relative to 2016. A significant proportion (47%) believe the improvement in hedge fund performance will continue and the 2017 benchmark will surpass the 2016 return (Fig. 5). Interestingly, nearly a quarter (23%) of fund managers were unsure how performance in 2017 would compare to 2016, perhaps an indication of widespread uncertainty in the industry at present.
In 2016, event driven strategies generated the highest annual return (+13.11%) of all top-level hedge fund strategies. At the other end of the performance spectrum, managed futures/CTAs, which recorded the best Q1 2016 return of all top-level strategies (+1.68%), finished the year with a return of just 1.12%.
Preqin asked respondents to predict how the seven top-level strategies would perform in 2017; using a weighted average of the rankings, fund managers predict that equity strategies will be the leading strategy in 2017 (Fig. 6). Credit strategies, the second best performing top-level strategy in 2016, are predicted to be the worst performing strategy in 2017 for the third year in a row. Meanwhile, with macro strategies expected to be the second best performing strategy in 2017 and managed futures/CTAs up to fifth, despite posting the lowest returns in 2016, fund managers anticipate opportunities in commodity markets in the coming year.
Planned Launches In 2017
Compared to the 29% of respondents that were planning on launching a new fund in 2016, 37% plan to bring a fund to market in 2017, a significant increase. Furthermore, over a quarter of respondents planning to launch a fund in 2017 will be launching a strategy that is new to their firm, thereby increasing their range of solutions available to investors.
Hedge Fund Fees: Investor Views And Fund Manager Reaction
We look at investors’ attitudes to hedge fund fees and conditions and how hedge fund managers are reacting to these concerns.
Management fees continue to be at the forefront of investors’ concerns. Although the majority of respondents to Preqin’s last three investor interviews reported that they had seen an improvement in this area, over three-quarters (76%) of investors surveyed in December 2016 want to see further improvements in management fees over the course of 2017 (Fig. 1).
As illustrated in Fig. 2, fund managers have reacted to investors’ calls for lower management fees: the mean fee for hedge funds launched each year has generally decreased over the course of the past decade, driving the average management fee across the industry to 1.56%. There has also been a notable drop in the proportion of new hedge funds entering the market charging a traditional 2.00% management fee; the proportion fell to an all-time low of 30% in 2016. Furthermore, 2014 represented the first year on record in which funds charging a 2.00% management fee no longer represented the largest proportion of launches: 41% of 2014 hedge fund launches charged a fee of 1.50-1.99%, compared with 35% charging 2.00%. Since then, these figures have both continued in contrasting trajectories.
Level Of Performance Fees
Approximately a third of investors surveyed in each of Preqin’s last three investor interviews have witnessed an improvement in the level of performance fee they are charged; however, nearly half (48%) of investors surveyed in December 2016 are seeking further improvements to the amount charged in performance incentives (Fig. 3).
Hedge fund managers have responded to this pressure and moved away from the standard 20% structure (Fig. 4); however, not at the same rate as management fees. While a significant 73% of funds launched in 2016 charge a 20% performance fee, this figure has declined from 87% in 2007. Furthermore, the proportion of funds deploying a performance fee of 15.00- 19.99% has nearly tripled since 2007, from 6% of launches to 17% in 2016.
How Performance Fees Are Charged
Although the performance fee has come under less scrutiny than the management fee in recent years, a growing proportion of investors are seeking a change in how this fee is charged rather than a change in the absolute level. The majority (57%) of those interviewed in the latest Preqin survey believe performance fees and how they are charged form a key area for managers to improve in the coming 12 months, up from only 26% in December 2015 (Fig. 5).
Consequently, a growing proportion of managers are setting restrictions on performance fees to protect investors’ capital, predominantly by using hurdle rates, high-water marks and clawbacks. High-water marks are the most commonly used provision – 77% of managers use them on all their funds – while clawbacks, which incentivize consistent performance and protect investors from further losses, are currently utilized by 10% of managers; however, a further 11% are open to including this provision in the future (Fig. 6). This suggests further receptiveness by managers to cater to investors’ demands and ensure they are not paid for short-term periods of positive performance.
As can be seen in Fig. 7, 57% of investors surveyed in December 2016 are looking for better transparency from hedge fund managers in 2017. One way in which managers have responded to this need is to offer a managed account structure, which allows investors greater transparency of the underlying investments and more control over the hedge fund manager’s decisions, as well as the opportunity to access more favourable fees. The proportion of hedge fund launches each year represented by managed accounts has doubled since 2010 as investors seek the benefits of the structure (Fig. 8). Furthermore, of the hedge fund managers surveyed by Preqin in November 2016, 32% plan to invest more in investor relations in 2017, compared with just 11% that intend to do so in 2016, as managers look to better serve their investors through increased communication channels.
Sample Firms That Reduced Fees In 2016
We review the latest news from the hedge fund industry, including Asia-based investors planning new investments in the coming year, and new hedge funds launched so far in 2017. Plus, our Chart of the Month looks at the 12-month cumulative returns of hedge funds.
Asia-based Investors’ Allocation Plans For 2017
Asia-based investors target a range of hedge fund strategies in a variety of regions. Tokyo-based Aino Investment Corporation is looking to invest in approximately 20-25 new hedge fund managers over the next 12 months. The fund of hedge funds manager is open to investing with managers employing macro and managed futures/CTA strategies on a global basis. The firm only considers managed account fund structures.
Over the next 12 months, Client Associates plans to add to its hedge fund portfolio; the Gurgaon-based family office invests directly in hedge funds primarily focusing on long/short equity strategies, but is also open to event driven hedge funds. In terms of geography, it only targets its domestic market.
Hedge Funds Launched In 2017
In Preqin’s November 2016 survey of 276 hedge fund managers, 37% reported plans to launch a vehicle in 2017, with equity and credit strategies funds accounting for 52% of these planned launches. Here, we take a look at some notable fund launches in the first two months of 2017.
Rimrock Capital Management’s Rimrock Total Return Strategies Fund I was launched in January 2017 and operates a fixed income arbitrage strategy. The fund invests exclusively in swap spreads which represent the yield difference between a US Treasury bond and a fixed-rate swap. The fund is structured as a closed-end private equity-style fund with a five-year legal life. It is scheduling its first close for the end of January with a final close no later than April 2017.
Also launched in January, Systematic Long/Short Global Equities Fund is a UCITS-compliant vehicle managed by RAM Active Investment. The fund seeks to achieve mid- to long-term capital appreciation, irrespective of market conditions, through a systematic, long/short equity-focused investment strategy.
Chart Of The Month
Investors withdrew a net $110bn from hedge funds in 2016 as a number of high-profile investors announced cuts to their allocations. As seen in Preqin’s recent H1 2017 Investor Outlook, investors see performance as the key issue facing the asset class in 2017, with a number of investors interviewed citing the current level of returns as a reason behind redemption requests in 2016. However, as 28% of investors surveyed believe hedge fund performance will improve in 2017, we take a look at the current 12-month cumulative return of the Preqin All-Strategies Hedge Fund benchmark to show how hedge fund performance could be reaching a six-year high.
The current 12-month cumulative return of 13.63% is one of the highest figures on record since the turn of 2011. 2016 witnessed stock market volatility around the world as European and US markets posted strong gains as investors reacted to Brexit and the election of Donald Trump, while 2017 began in a similar vein as UK stock markets reached record highs. It seems the market conditions that arose from various unexpected macroeconomic events over the past 12 months created positive opportunities for hedge funds, leading to one of their best return-generating runs
Hedge Funds – Performance Benchmarks
We provide the latest hedge fund performance benchmarks.
Hedge funds have posted strong returns in the first two months of 2017. February saw positive returns across all fund types and strategies with the Preqin All-Strategies Hedge Fund benchmark up 1.18%, slightly below January’s return of 1.43%. Relative value strategies were the only top-level strategy to record a loss in February (-0.04%). Equity strategies were once again the top performing strategy, driving their 2017 YTD return to 3.48%, with event driven strategies in second (+3.19%).
Twelve-month returns are also strong across various hedge fund structures (Fig. 2). The 12-month cumulative return of 13.63% represents one of the best performing 12-month periods for hedge funds since the turn of the decade. However, there is stark contrast when comparing the performance of CTAs over the same period, with these vehicles losing 1.32% over the past 12 months.
With hedge fund industry AUM increasing 3.2% to $3.25tn, despite investors withdrawing $110bn over the course of 2016, we examine which strategies recorded outflows and how fund performance can affect inflows.
Hedge Fund Investors In Asia
We examine the make-up of hedge fund investors based in Asia by type, location, allocation, strategy preferences and more.
Fund Searches And Mandates
We analyze the fund searches and mandates issued by hedge fund investors in February 2017.
Article by Preqin
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