December has historically been a month where redemption pressures far outweigh new allocations as investors wait for the new year to put money to work. This December, however, investors removed the least they’ve removed from the industry in December in seven years. While seemingly a good sign for an industry in need of good signs, these investor tendencies may also signal negative sentiment toward public markets.
The last two times, post-2008, investors chose to allocate at least this much to equity strategies (2014, and 2010) the ensuing years saw major equity market pullbacks. While allocations to other strategies were mixed, indicating a certain level of dissatisfaction with performance remains, the return of interest in alternative public market equity strategies is intriguing, and a theme to watch closely in 2018.
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- Investors removed an estimated $8.35 billion from hedge funds in December, the industry’s lightest level of December redemptions since 2010.
- Equity strategies dominated industry flows in 2017, which has not historically been a good omen for equity markets.
- Macro fund flows were negative in December for a fourth consecutive month.
- 2017 was a roller-coaster year for managed futures investors.
December Redemption Pressures Were Lightest Year-End Since 2010
Investors removed an estimated $8.35 billion from hedge funds in December, a month which has historically seen the largest redemption pressure of the year. Net flows into the industry for the year ended at $30.30 billion, and total industry AUM ended 2017 at its highest level on record.
- This December outflow should be viewed as a positive for the industry.
Since 2008, every December, except for one (2010), has seen investor redemptions outpace new allocations resulting in a net outflow. The last three Decembers have each had elevated redemption pressures with over $20 billion net removed in each. From 2009 to 2016, the average net outflow in December was just over $16 billion. With a net removed of less than $10 billion in December 2017, while the number is obviously negative, on a comparative basis this was a good ending to the year for the industry.
- Redemptions in December were more concentrated than any other month in 2017.
Over 63% of overall outflows in December came from the top 5th percentile with outflows. This is a measure of what proportion of all outflows comes from those with the largest outflows; the higher the %, the more outflows are concentrated among a small proportion of managers. For the rest of 2017, the average was 10 percentage points lower, or 53%. The concentration of allocations among those with the largest allocations was above the year-long average (combine the two, and it reinforces the industry consolidation theme), but below the prior two months.
- Investors aggressively allocated to alternative equity strategies in 2017, historically not a good sign for equity markets.
Whether the numbers are an indication institutional investors are uneasy about global equity valuations and were looking for alternatives to long-only strategies, or a sign of satisfaction with the return profiles from the strategies, it is clear investors were on the hunt for equity-focused hedge funds in 2017. The inflow of $30 billion was the third highest post-2008 inflow to equity strategies behind 2014 ($70 billion), and 2010 ($32 billion). It should be noted that in each of the following years (2015 & 2011), the S&P 500 had its two lowest post-2008 annual returns (+1.4% and +2.1%, respectively).
- December was the fourth consecutive month of net outflows from macro strategies, but 2017 flows were ultimately positive.
Net flows for macro strategies turned negative in September, and were increasingly negative in each ensuing month. While there are products which ultimately performed well in 2017 that have been experiencing redemption recently, this relatively small group dominating outflows contains a mix of both good and bad 2017 returns, though their average return in Q2 was -1.4%.
- Investors in managed futures strategies had a year which must have been difficult to explain.
Early year performance gains were followed by net inflows, which were then followed by performance losses, which were followed by redemptions, which were followed by industry leading performance to end the year.
2017 Emerging Market Hedge Fund Flows Were the Most Positive Since 2009
- Net inflows to EM hedge funds were very positive in 2017, particularly into Asia (primarily China), and credit strategies.
Four of the five largest EM asset gainers in 2017 were fixed income-focused, and five of the ten largest were focused on Asia. Latin America and emerging Europe were not in high demand from investors.
- China-focused hedge funds attracted new assets in 2017.
Two-thirds of reporting China-focused hedge funds saw net inflows in 2017, which is a far better ratio than the rest of EM strategies (43% had inflows), and the overall hedge fund industry (42% had inflows). Net flows were positive for the group with reporting strategies taking in an estimated net of $2.2 billion
- European-domiciled firms were the largest asset gainers in 2017, driven by demand for equity strategies.
Two of the three largest asset gainers in Europe in 2017 were focused on equity markets. The next three largest asset gainers were each managed futures strategies, which is interesting because each of the three largest asset losers in 2017 were also managed futures strategies.
Article by eVestment