Hedge Funds Q2 2016 Asset Flows: ALL Activists Disappoint As Stars Like Valeant FallsVW Staff
Hedge Funds Q2 2016 Asset Flows by Preqin
Check out the part about activists pretty shocking stats
Drivers of Change in the Hedge Fund Industry: Performance
With recent returns lower than investors have come to expect, the performance of the hedge fund industry is under increasing scrutiny. Joe McGee takes a closer look at the performance of the asset class and its implications, using data from the 2016 Preqin Alternative Assets Performance Monitor and upcoming Preqin Investor Outlook: Alternative Assets, H2 2016.
- With 79% of investors reporting that their hedge fund investments have fallen short of expectations over the past 12 months, both fund managers and investors have identified performance as a key issue in the hedge fund industry today.
- Total industry returns have fallen short of investor expectations; however, as the Preqin All-Strategies Hedge Fund benchmark encompasses a range of vehicles investing across different strategies, there are some funds – particularly CTAs – that are meeting investor requirements.
- Due to the proliferation of funds in recent years and the wide dispersion between the top performing strategies and individual managers in the industry today, investors are finding it more difficult to pinpoint the most attractive investment opportunities in the current environment.
Following returns of 1.97% in 2015, the Preqin All-Strategies Hedge Fund benchmark returned 1.09% in the first six months of 2016. With industry returns considerably below the double-digit figures experienced in 2009, 2010, 2012 and 2013, investors have become increasingly concerned about the impact of hedge fund performance on their portfolios: 79% of investors surveyed for the upcoming Preqin Investor Outlook: Alternative Assets, H2 2016 felt that their hedge fund investments had fallen short of expectations over the past 12 months, up from 33% in December 2015 (Fig. 1.).
Using data from the recently launched 2016 Preqin Alternative Assets Performance Monitor and forthcoming Preqin Investor Outlook: Alternative Assets, H2 2016, we look at how different strategies have performed, investor views on hedge fund performance and the role that the asset class can play in investor portfolios.
Behind the Headline Numbers
Behind the industry benchmark, there are a wide range of vehicles investing in different instruments, strategies and regions – some of which have performed better than others in the current economic environment (Fig. 2). Among top-level strategies, macro strategies were the top performing over the past 12 months (+3.14%), followed by CTAs (+2.49%). Relative value strategies were the highest returning strategy over a three-year period (+5.22% annualized) with the lowest three-year volatility (1.84%).
Equity strategies, on the other hand, have performed worse than other strategies over the past 12 months, particularly in the second half of 2015 (-4.35%), when the volatility in Chinese financial markets spread to equity markets worldwide. Although they have better long-term performance (+4.79% three-year annualized), they also have the highest three-year volatility (6.17%).
For individual sub-strategies, there is a large difference between the top performing sub-strategy (CTA – Counter-Trend, +7.11%) and the worst performing (Sector-Focused, -11.01%, Fig. 3). Other top performing sub-strategies include asset-backed lending (+6.36%), pattern recognition CTAs (+6.29%) and relative value arbitrage (+6.13%), while distressed and long bias funds also had a difficult year (-7.41% and -6.14% respectively).
Factors Affecting Performance
When asked about the major events affecting performance in H1 2016, a large proportion of fund managers felt that continuing uncertainty about China had negatively impacted performance in the first half of the year, particularly for fund managers based outside North America and Europe (71%, Fig. 4). In North America, crowding of trades was also seen as a negative factor, with 41% of respondents believing that this had negatively affected their funds.
On the positive side, significant proportions of North America- and Europe-based fund managers felt that they had benefited from changes in oil and commodity prices in the first half of the year. Fund managers based elsewhere felt that interest rate policy in Europe, Japan and the US had benefited their funds.
Investor Satisfaction with Performance
Although investors surveyed by Preqin reported a general dissatisfaction with the recent performance of the asset class, they recognized that some funds had outperformed others and expressed varying levels of satisfaction with different hedge fund strategies (Fig. 5). Among the better performers relative to investors’ expectations were systematic CTAs: 92% of investors felt that these met their targets. Discretionary CTAs and credit strategies also performed comparatively well, meeting the expectations of 63% and 50% of investors respectively. At the other end of the scale, no investors surveyed felt that their activist investments had met their expectations – a sign of a difficult H1 2016 for activist funds marked by, among other things, the continued share price decline of Valeant Pharmaceuticals, a former activist favorite.
While many investors feel that some hedge fund strategies have been meeting their targets, a significant proportion remain concerned that their overall portfolio of hedge funds has not been living up to expectations recently: 41% of investors surveyed by Preqin reported that they have reduced confidence in the ability of hedge funds to achieve portfolio objectives over the past 12 months, compared with only 12% that reported increased confidence (Fig. 6).
A key difficulty for investors is fund manager selection: even within strategies, returns vary considerably between different funds. As shown in Fig. 7, the interquartile range for the returns of equity strategies funds over the previous 12 months is over 15 percentage points, while credit strategies have the least variation, at 6.8 percentage points. With more than 15,900 active hedge funds open to investment today, investors are finding it harder to identify the better performing funds. Forty-six percent of investors surveyed by Preqin for the upcoming Preqin Investor Outlook: Alternative Assets, H2 2016 stated that it is currently more difficult to source attractive investment opportunities than 12 months ago, compared with only 6% that are finding it easier.
The Role of Hedge Funds in Investor Portfolios
Nevertheless, despite investor concerns about short-term performance, returns over the longer term have been more promising, with five-year annualized returns of 5.26% for hedge funds and 4.53% for CTAs. Such returns are often compared unfavourably with equity indices such as the S&P 500 Index, but these comparisons are not always justified. Investors surveyed by Preqin have previously indicated that they value hedge funds less because of the possibility of high absolute returns than because of the role that they can play in helping to diversify investors’ portfolios, as well as providing low correlation to other asset classes and reducing portfolio volatility.
The 2008 Global Financial Crisis (GFC) highlighted the extent to which many institutional investors needed to diversify into alternatives such as hedge funds, as the traditional “60/40” portfolios of equities and bonds failed to protect assets during the crash. Hedge funds fell only -17.35% overall in 2008, compared with -38.49% for the S&P 500 Index, with certain strategies such as macro strategies performing better (+4.35%). In the aftermath of the GFC, an increasing number of institutions turned to hedge funds to help meet long-term liabilities while reducing risk within their portfolios.
The GFC has been followed by a prolonged bull run in equity markets and there are signs that some investors may be losing patience with hedge funds as they are not adding the high returns of traditional equity markets. However, with continuing uncertainty about the health of the global economy and the risks posed to financial markets by geopolitical events, recent outflows of capital from the asset class may be reversed if hedge funds can once again prove their value in helping investors meet long-term return goals, with less volatility and risk than investing through equities. As shown in Fig. 8, hedge funds have consistently captured more of the upside of the S&P 500 Index than they have the downside in recent years, with a three-year upside capture ratio of 64% in June 2016, compared with a 27% downside capture ratio. As a result, hedge funds have tended to experience smaller drawdowns than the S&P 500 over the past six years (Fig. 9).
Both fund managers and investors surveyed by Preqin believe that performance is one of the key factors driving change in the hedge fund industry (see Preqin Special Report: Hedge Fund Manager Outlook and the upcoming Preqin Investor Outlook: Alternative Assets, H2 2016 for more information). The disappointment of a large proportion (79%) of investors with the returns of hedge funds over the past 12 months is leading to reduced confidence in these funds ability to meet portfolio goals, which in turn has led to outflows of capital from hedge funds in recent quarters (see page 7).
Industry performance has brought to the fore the issue of fees and the extent to which fund manager and investor interests are properly aligned and shifted the balance of negotiations in favour of investors. Fifty-nine percent of respondents felt that fund terms and conditions had shifted in favor of investors over the past 12 months, compared with only 8% that felt that they changed in favour of fund managers.
In order to address investors’ concerns and ensure continued allocations to hedge funds, fund managers will need to take measures to reassure investors about their funds and educate them about the potential benefits of the asset class (Fig. 10). Fund managers are seeking to do so by improving transparency on their strategy, risks and business, investing in their middle- and back-office infrastructure and leading educational initiatives to improve knowledge about the industry among CIOs and the wider investing public. Their ability to do so as well as continue to generate better returns throughout the rest of 2016 (see page 11), will be key requirements for the hedge fund industry to continue to grow in the future.
Q2 2016 Hedge Fund Asset Flows
In this month’s lead article, we examine recent hedge fund asset flows by strategy, performance, fund size and fund manager headquarters using data from Preqin’s Hedge Fund Online.
Following net outflows of $5.0bn in the second half of 2015 and outflows of $14.3bn in Q1 2016, there have been further outflows in Q2 2016. Hedge funds have seen net outflows of $19.9bn in Q2 2016, taking total outflows over 2016 YTD (as of 30 June 2016) to $34.2bn (Fig. 1).
CTAs saw the highest net inflow of assets among all strategies in H1 2016 ($16.6bn), although this fell into the hands of a relatively small proportion (38%) of managers in this sector (Fig. 3).
Despite posting some of the lowest returns of any hedge fund strategy in H1 2016, relative value strategies secured $10.4bn in net inflows over Q2 2016, the highest of any strategy in the quarter and negating the $8.7bn in outflows over Q1. Both credit and equity strategies have suffered over the first half of 2016, losing $26.2bn and $25.2bn in assets respectively, despite credit strategies recording some of the strongest returns.
Fig. 4 shows that funds that have performed well recently are more likely to pick up inflows. Forty-three percent of funds that made gains of 5% or more in 2015 have seen net inflows over the first half of 2016 – a higher level than funds that generated lower performance in 2015. This reflects the importance investors are placing on performance.
The four strategies rated by the largest proportion of institutional investors in hedge funds as meeting expectations in H1 2016 – systematic CTAs, discretionary CTAs, credit strategies and macro strategies – are also the four leading strategies to which investors plan to allocate more capital over the rest of 2016 (Fig. 2). The forthcoming Preqin Investor Outlook: Alternative Assets, H2 2016 provides more detailed analysis on investors’ plans for hedge funds in the coming year.
Editor’s View: Industry News
We present the latest hedge fund industry news, including recently launched UCITS vehicles and investors searching for new funds using data from Preqin’s Hedge Fund Online.
London & Capital Asset Management, a $3.5bn asset manager based in the UK, is planning to invest in four or fi ve UCITS funds over the next 12 months. Currently, London & Capital Asset Management invest approximately $150mn in hedge funds.
Among the newly launched UCITS vehicles this year is Milltrust SEDCO MENA Fund. The fund launched in June 2016 and is domiciled in Dublin. Milltrust SEDCO MENA Fund aims to achieve long-term capital returns by taking long positions in Shariah-compliant equities represented by companies in the MENA region. The team applies a combination of top-down thematic research and bottom-up investments in order to build a high conviction and concentrated portfolio of 30-50 positions. It is managed by Sedco Capital, a privately owned asset manager in the GCC.
Although the Preqin All-Strategies UCITS benchmark is underwater in 2016 YTD (-0.70% as of 31 July 2016), there are some funds that have performed significantly better. Among these is JPMorgan Funds – US Select Equity Plus Fund C Dist GBP. The fund employs a 130/30 strategy and is up 8.12% YTD (as of 31 July 2016). The strategy has approximately $2.75bn in assets under management.
Investors Searching for New Funds
In light of outflows over the course of the fi rst half of 2016 (see page 7), finding investors searching for new funds over the rest of the year and into 2016 becomes more important than ever. Using data from our Fund Searches and Mandates feature on Hedge Fund Online, which enables fundraising professionals to identify institutions looking for investors today, we take a closer look at some latest news in the investor sector. Astmax Asset Management, a Tokyo-based fund of hedge funds manager, will be looking to target funds employing equity market neutral and fixed income arbitrage. Rome-based Banca Nazionale Del Lavoro, which invests 5% of its €100mn assets under management in hedge funds, will be searching for multi-strategy, multi-asset funds of hedge funds in the next 12 months. Envoi, a Minnesota-based family office, is another investor looking for new funds in the next 12 months: it plans to invest up to $50mn in 3-5 new hedge funds.
Chart of the Month
The hedge fund industry faces many challenges in 2016: notably, outflows following concerns expressed by investors on the performance of the asset class. This, coupled with some high profi le investors pulling capital out of hedge funds, with New Jersey State Investment Council the latest pension scheme to announce cuts within its hedge fund portfolio, has raised many questions about the future of the asset class.
However, despite the current high levels of disappointment with the performance of hedge funds and potential for further outflows in H2 2016, investors can see the value in hedge funds within their portfolio. This value was proved during the Global Financial Crisis when institutions began to add these funds in order to diversify their holdings and reduce risk and losses during market corrections. However, despite an eight-year gap since the start of the GFC and a prolonged bull market, many investors remain mindful of the power that hedge funds have to reduce the risk they hold within their portfolios.
The majority (55%) of institutional investors that participated in Preqin’s survey in June believe that risk within their portfolio would increase if they removed hedge funds from their holdings. Concerns about performance may be dominating the hedge fund sector in 2016, but the majority of investors continue to recognize the value these funds can have in reducing risk.
Hedge funds continued to rise in July, with the Preqin All-Strategies Hedge Fund benchmark posting gains of 2.17% for the month. Equity strategies performed particularly strongly, up 2.78%, buoyed by the bull market in stocks since the Brexit vote in June. Event driven strategies also stood out with gains of 2.71%, but top of the pack were activists which added 3.67% in July – their best month of the year so far. Despite a poor start to 2016, activists have since seen five consecutive months of gains, with March and July being particularly strong. The worst performance for July came from discretionary CTAs (-1.37%), although these funds remain in positive territory for the year.
UCITS Hedge Fund Launches
Ross Ford analyzes recent trends in the market for alternative UCITS funds, looking at the growing importance of Ireland as a UCITS fund domicile and the increasing number of UCITS funds launched by US-based fund managers.
Luxembourg is the leading centre for UCITS hedge funds and is the domicile for 54% of funds tracked by Preqin’s Hedge Fund Online database (Fig. 1). Ireland, however – the second largest market in terms of proportion of fund launches – has seen its share of new fund launches increase in recent years. In 2015, Ireland overtook Luxembourg and became the most commonly utilized domicile by newly launched UCITS hedge funds, accounting for 55% of total fund launches versus 44% for Luxembourg (Fig. 2). This trend has continued into 2016, with Ireland accounting for 61% of alternative UCITS launches so far this year, compared with 37% for Luxembourg.
The increase in launches follows favourable regulatory developments in Ireland, with the implementation of the Irish Collective Asset-management Vehicles Act (ICAV) in March 2015. The associated ICAV fund structure is specifically designed for investment funds and helps to reduce the administrative burden and costs to fund managers by avoiding the need to comply with certain Irish company law requirements; as well as this, the structure counts as a tax transparent entity for US federal income tax purposes.
In addition, the growth of the Irish market may be due to the recent increase in US-based fund managers launching UCITS-compliant vehicles. Following the implementation of the Alternative Investment Fund Managers Directive into the legislation of EU member states in 2013-2014, the proportion of UCITS launches by US-based managers has increased noticeably, from 16% in 2014 to 29% in 2015 and 27% in 2016 so far (Fig. 3). Some US-based fund managers seeking to raise capital from Europe-based investors have launched UCITS funds as a means of accessing investors based in Europe through the UCITS passporting regime, without having to comply with the AIFMD. Large proportions of these new launches have been domiciled in Ireland: 53% in 2015 and 70% in 2016 to date.
Asset-Backed Lending and Mortgage-Backed Strategies
Gary Broughton and Alesi Thomas take a look at asset-backed lending and mortgage-backed strategies hedge funds, two of the top performing credit sub-strategies.
Michael Brown examines the geographic and strategic preferences of foundations investing in hedge funds, their preferred route to market and average allocation to the asset class.
Fund Searches and Mandates
We look at the strategies and regions hedge fund investors plan to target in the next 12 months, as well as investors planning new investments.
See the full PDF below.