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After A Difficult 2015, Hedge Funds Need To Rise To The Challenges Of 2016

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After A Difficult 2015, Hedge Funds Need To Rise To The Challenges Of 2016 by Preqin

2015 proved a challenging year for the hedge fund industry. Although the year started well, with hedge funds making gains in each of the first five months of 2015, a series of events across the globe hit many of the markets traded by hedge funds. This resulted in four months of losses from June to September, the longest losing streak for hedge funds since 2008. By the end of 2015, hedge funds had returned just 2.02%, representing the Preqin All- Strategies Hedge Fund benchmark’s worst performance since 2011. Although the benchmark outperformed the S&P 500 over the year, this poor performance did not go unnoticed by investors: approximately a third of institutional investors reported to Preqin that hedge funds had failed to meet expectations in 2015. Many fund managers themselves were disappointed with performance in 2015: 44% of fund managers reported that their funds had failed to meet return objectives in 2015. However, amid the performance difficulties of 2015 there were some bright spots; in particular, the industry recorded net capital inflows of $71.5bn, taking the size of the hedge fund industry to nearly $3.2tn.

Hedge Funds May Face More Challenges Ahead in 2016

With 2015 behind us, what does 2016 hold for the hedge fund industry? In our end-of-year survey of 150 institutions, more investors indicated that they will invest less capital in hedge funds in 2016 than in 2015, which could mean that raising new capital, as well as retaining capital, could become increasingly difficult over the course of this year. Although we have seen similar levels of disappointment in hedge fund performance to 2015, in 2011 and 2014 for instance, this is the first time (since Preqin began tracking institutional investor activity in hedge funds in 2007) that we have seen a net change in appetite in favor of investors taking capital out of their hedge fund portfolios.

Fund managers and investors agree that performance will be the leading challenge for the hedge fund industry in 2016, so perhaps performance will be the key to the success of the industry over the year. If hedge funds can navigate the changeable economic environment and continue to show better performance in times when traditional markets are struggling, then maybe the value of hedge funds can be proved to those investors that are currently taking a cautious approach to the asset class.

During periods when many investors believe performance is poor, the fees associated with hedge funds are often increasingly scrutinized. Although management and performance fees – as shown in ‘Management and Performance Fees’ (page 50) – have been on a general downward trend over recent years, high levels of investors still want to see further reductions in these terms over the course of 2016. The need to change fee structures could add additional pressures on hedge fund managers. The cost of running a successful hedge fund has increased over recent years as fund managers have invested in improving their business infrastructure to cope with an increasingly sophisticated client base and to adapt to new regulations. The calls to cut fees further could make it more difficult to run a profitable business in 2016 – in particular for smaller managers.

How to Successfully Navigate 2016

Although further investment in their business operations is difficult in light of calls for reduced fees, it could be vital to the success of a hedge fund in 2016. Investors are seeking improvements in performance; therefore the 41% of fund managers looking to beef up their portfolio management capabilities may be better placed to navigate the volatile environment in 2016 and win back investor favor. Transparency is another issue at the forefront of investors’ minds. Investors increasingly want to better understand the source of their hedge fund performance, for better or worse, and those fund managers that are able to provide the much demanded transparency, as well as educate investment offi cers and trustees on the benefi ts of investment in hedge funds, may be well placed to retain existing clients as well as gain fresh assets.

Originally a product used exclusively by wealthy individuals and families, institutional investors began to increasingly use hedge funds in the early 2000s. Today, Preqin tracks over 5,000 institutions that invest in hedge funds, with this number growing on a daily basis. Despite some notable investors cutting hedge funds from their portfolios over the past few years – CalPERS, PFZW and Railpen to name a few – the majority of institutional investors look set to remain active in hedge funds over the longer term. However, hedge fund managers have also reported that sources of private wealth – family offices and wealth managers – are once again increasing their allocations to their funds. With changes to regulations allowing the proliferation of alternative structures in hedge funds, such as UCITS in Europe and alternative mutual funds in the US, fund managers have also reported growth in assets from retail clients. As the universe of investors active in hedge funds becomes increasingly diverse, the hedge fund managers with products that can appeal to a variety of investors may be rewarded with a growing asset base.

For many investors, 2016 may be a time to re-evaluate their hedge fund portfolio. The performance of the industry as a whole has been somewhat disappointing, with two back-to-back years of returns below the level expected by many investors. However, there are some bright spots, with some strategies and regional funds showing strong performance in 2015, and many individual funds showing significant success. Investors may want to rebalance their portfolios to ensure they are well diversified in order to navigate a potentially changeable economic environment, and tools such as our ‘Most Consistent Top Performing Hedge Funds’ league tables (see pages 27-31) may help in assessing the long-term success of a manager. With traditional markets showing signs of problems at the start of 2016 – for instance, the Dow Jones Industrial Average and the S&P 500 showed their worst ever results during the first trading sessions of the year and the FTSE 100 crashed into a bear market in the third week of 2016 – the need to diversify into all-weather or non-correlated assets may become more pressing and investors may need to rethink their plans to cut back on hedge funds over the year.

Hedge Funds – Performance Benchmarks

Hedge Funds

Hedge Funds

Overview of Hedge Fund Managers

Preqin’s Hedge Fund Analyst tracks over 6,000 fund management firms operating in the hedge fund sector. These institutions manage a range of hedge fund investment products, from traditional commingled funds to liquid alternatives. In this section we present a breakdown of the hedge fund manager universe.

Regional Breakdown

North America is the most established region in the hedge fund industry and accounts for the majority (60%) of managers (Fig. 4.9). Nineteen percent of hedge fund managers are based in Europe; of these, more than half (52%) are headquartered in the UK. Asia- Pacific hedge fund managers constitute 17% of all firms within the industry, with the majority of these based in the financial centers of Hong Kong, Australia and Singapore. Beyond North America, Europe and Asia-Pacific, the industry is less developed and only 4% of managers are located outside these key regions (Rest of World). Of the Rest of World-based hedge fund managers, 37% are headquartered in Brazil, followed by 23% in South Africa and 8% in the United Arab Emirates.

Assets under Management

Hedge fund industry assets, as of 30 November 2015, stood at just under $3.2tn, increasing by $178bn from 2014 (Fig. 4.10). North America saw the greatest absolute increase as the assets of managers in the region grew by $116bn to over $2.3tn over the course of the year. However, in percentage terms, the 5% increase in North American assets was surpassed by 12% growth in Europe, as the assets under management (AUM) of Europe-based managers increased by $76bn to $685bn. This followed strong growth over the year in several European countries, including the UK, France and Switzerland. Conversely, AUM in Jersey has decreased considerably over the past year. This is largely attributable to changes within the two largest fund managers based in the territory: Brevan Howard and BlueCrest Capital. DW Partners spun out of Brevan Howard in January 2015; the new fi rm is headquartered in New York. More recently, BlueCrest announced in December 2015 that it would begin returning investor capital in order to convert to a family office.

Hedge Funds

The Asia-Pacific region manages $159bn, a 10% increase from 2014. The largest change was observed in regions beyond North America, Europe and Asia: AUM in Rest of World fell from $67bn in 2014 to $39bn in 2015, a decrease of 52%. The greatest decline was seen in Brazil, where AUM fell by $22bn during the year. Part of this reduction in assets can be attributed to the Brazilian Real’s.

Asset Flows in 2015

The hedge fund industry saw a net inflow of $71.5bn during 2015, as of 30 November 2015 (Fig. 4.33), with the majority of this figure coming in the first half of the year. More than half of the inflows were secured by equity strategies despite net outflows during the third quarter of the year. Many investors pulled their capital out of the strategy following the global volatility in public markets during this time. Despite the volatile performance of CTAs during 2015, investors continued to allocate capital to the strategy with $25.4bn of new capital inflows during the year.

Regionally, North America-based funds have seen the largest inflows throughout the year, with $79.6bn of inflows outstripping the $31.7bn of new capital received by European funds. Following strong inflows during the first half of the year, Asia-Pacific-based hedge funds had a difficult H2 and ended the year having suffered an overall net outflow of $1.3bn.

Preqin’s analysis shows that a greater proportion of larger funds received net inflows compared to smaller funds (Fig. 4.34). More than half of funds over $500mn in size received inflows during 2015. In contrast, 53% of funds managing less than $100mn experienced net redemptions during the year.

There were varying fortunes across different strategies in 2015. More than half of CTAs secured net inflows during the year, with 52% of funds receiving new capital, whereas 58% of macro strategies hedge funds saw net redemptions (Fig. 4.35).

Preqin estimates industry asset flows from performance and asset growth information for over 12,200 hedge fund track records, as showcased on Preqin’s Hedge Fund Analyst. Flows are estimated based on a sample of funds with available size and performance data and scaled up based on the proportion of represented capital by strategy, headquarters location and fund classification.

Hedge Funds

Hedge Funds

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