Emerging Hedge Funds Cautiously Optimistic Despite ‘Trendless Market’

Terry Flanagan

Emerging hedge funds are holding steady in the face of prolonged market uncertainty, working to find the silver lining in what is expected to be a proverbially cloudy second half to 2012, as institutional investors continue to persevere with the smaller manager.

For Milman Capital, an emerging long/short equity fund based in New York, that silver lining, whilst elusive, may still be attainable with the right strategic adjustments.

“From what we see, the volume and momentum has definitely dried up in a lot of sectors, so shorter-term trading is, I think, the newer trend,” Peter Milman, co-founder of Milman Capital, told Markets Media. “People are just trying to take trends out of the market and have less risk overall. Stuff that worked a year ago and two, three years ago is not working any more. You constantly have to be re-evaluating your investment strategy, and that’s something that we’re always doing.”

In the midst of trading volume doldrums typical of late summertime and macro trends ranging from the ongoing drama in Europe to the dreaded fiscal cliff, U.S. equity markets are experiencing continued ambiguity exacerbated by the upcoming American presidential election in November.

“Volumes have been declining for the past four years, and I haven’t seen any absolute correlation between elections and trading volume,” Steve Simmons, managing director at Southport Harbor Associates, a Connecticut-based firm specializing in introducing alternative investment managers to institutional investors, told Markets Media. For Simmons, the U.S. election is only one of many elements influencing the current state of volatility.

Milman, though, sees a chance for hedge funds to perform well after the November presidential race despite the persistence of what he calls “a trendless market”, though, like Simmons, he does not expect any sustained rise in trading volume immediately after the election.

“It depends on what policies the [new] president will implement,” said Milman. “Usually, there’s some kind of volume spike right after, when the new president’s announced, but it’s really about the policies. There’ve been plenty of bull markets with both Democratic and Republican presidents. We believe there’s a lot of money on the sidelines that’s just waiting for these macro trends to settle down.”

Global macro influences and tepid equity markets aside, hedge funds—emerging ones, especially—seem to remain a decent bet for investors, and Simmons credits third-party service providers and the rise of separately managed accounts for this optimism.

“More than ever, the hedge fund industry is really well equipped to take advantage of all the tools available today,” said Simmons. “Third-party service providers, especially the top-tier ones, provide transparency [while] investors, especially the big pensions and institutions, can mitigate their risk via separately managed accounts. Emerging funds should really take advantage of all those tools in order to get those allocations.”

Simmons adds that the recent swing of institutional investors towards emerging managers, while still a small portion of their overall portfolio, reflects the fact that such smaller funds have historically outperformed the market. In its “2012 Hedge Fund Investor Review” Preqin underscores investors’ continuing commitment to the hedge fund space despite lackluster performance in the sector in 2011:

“With concerns over slow growth and the eurozone sovereign debt crisis continuing to hit hedge fund performance, investors retained a degree of skepticism towards the asset class over 2011. Despite these results, investors still retain confidence in the asset class to perform its portfolio objectives.” The Preqin report goes on to state that 20% of investors surveyed for the 2012 report are still confident that the hedge fund sector will maintain an edge over the market.

“It’s really a combination of things,” said Simmons. “As a fund, you have to be ready from day one to be ‘institutionalized’, and that means being open to due diligence, transparent service providers, separately managed accounts and, most importantly, performance. You have to perform.”

Milman Capital, though, appears to be doing just that. “We’re constantly adapting to the needs of our investors, people want reduced fees—the 2/20 model is slowly becoming outdated—but we’ve been able to charge two and 20 because of our returns,” said Milman. “Everyone’s really looking for transparency, too. We have nothing to hide, so we make our investors happy and work with each investor individually.”

Indeed, it appears that with a healthy dose of adaptability and transparency, both hedge funds and their investors may still have reason to be cautiously optimistic going into the latter half of 2012.

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