Has the market for hedge funds finally turned?

4th November 2011

The group said that losses had slowed in October and outflows from its funds had moderated. Has the market for hedge funds finally turned? Or has their credibility been permanently dented by weak performance through the market turmoil of the past few years?

Recent fund sales figures from, among others, Cofunds and the Investment Management Association point to one conclusion – investors don't know where to invest: Bonds look expensive, equities are volatile, property is weak. This has led to a general preference for broad-based products.

The cautious managed sector is by far the most popular, but investors also prefer global emerging markets over single country funds, the UK All Companies sector over UK equity income.

This should have played into the hands of the alternative investment sector. After all, the one sector that should be able to make money in this climate is hedge funds. Hedge fund managers have often said that they do best in climates of high volatility. The only trouble is, they haven't.

Hedge funds in falling markets

Investors hold hedge funds, by and large, to protect them against falling markets. They should be lowly or non-correlated to other asset classes and as such should act as a portfolio diversifier. The Dow Jones Credit Suisse indices shows the overall performance of individual hedge fund strategies here.

This demonstrates that how weak hedge funds have been in 2011 with the weakest areas event driven and global macro funds.

This is supported by some individual horror stories. John Paulson of Paulson & Co famously called the subprime crisis correctly, but until relatively recently 2011 was proving an annus horribilis.

Fortress profits have also slumped on the back of weaker performance.

Man Group saw its share price slide earlier in the year when the market was disappointed by high net outflows from its funds.

This FT article discusses a weak year for the ‘masters of the universe':

"The fact that the "masters of the universe" have got it so wrong is a sign of how upside down the investing world is today. Everyone has struggled, with two-thirds of managers of stock funds failing to beat the S&P 500 index benchmark in the past three years, according to Standard & Poor's."

Hedge fund success

However, Man's results are not the only signs that the tide may be turning for the hedge fund sector. Fund flows have held up well, even in funds with weak performance. This BarclayHedge and TrimTabs Investment Research data suggests that $6.1bn moved into the sector in August alone.

When the Paulson fund opened for redemptions, they were not as bad as expected. 

The Economist offers two potential explanations for the fact that hedge funds have retained assets:

"The good news is that investors seem to have learned a valuable lesson from 2008: don't sell an asset at what may be its trough. Many investors dumped their hedge-fund investments as soon as they could when the market collapsed in 2008, only to miss out on the market rally in 2009. The more depressing explanation for why investors are sticking with Mr Paulson is that they have few good alternatives."

Certainly, in many cases, hedge funds may not have delivered as people had hoped, but they have delivered better results than many long-only managers and therefore there is little incentive to switch.

However, as the Reuters article points out, it has tended to be the big name managers that have succeeded in retaining assets. The days of a rookie manager attracting billions are long gone.

The real legacy of the hedge fund wobble may be seen in pricing. Investors may no longer see fit to pay high annual management charges and chunky commissions for funds that haven't done as well as promised. There are signs this is already happening.

Equally, investors may feel within their rights to demand more transparency from their hedge fund managers. Launching a hedge fund as a strategy for speedy riches may no longer work. Hedge funds can recover, but perhaps not in their current guise.

More from Mindful Money:

Hedge Funds fail to protect…again

Hedge Funds: To be feared or favoured?

Profit taking, but at what cost?

Alternative investment tools – break away from the herd

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