Hedge-Fund Investors Hang In

Terry Flanagan

Hedge funds reported uninspired October performance, but there’s little evidence of investors quitting.

Alternative investment managers have not had a great year, but investors have so far kept the faith that things will turn around.

The Morningstar MSCI Composite Hedge Fund Index, an asset-weighted composite of nearly 1,000 hedge funds in the Morningstar database, rose 1.1% in October, compared with a 10% increase for world equity indices.

Such results suggest that investors may be growing antsy and inclined to throw in the towel, especially if the underperformance continues. But according to recent fund-flow information, outflows are running at modest levels.

Single-manager hedge funds in Morningstar’s database overall experienced net outflows of $165 million in September. Even including those outflows, hedge funds in Morningstar’s database collectively attracted inflows of $19.1 billion in the first nine months of the year and $20.2 billion over the last 12 months through September. So there would have to be massive outflows in the fourth quarter to put a serious dent in what has been a good year for capital raising.

Morningstar analyst Nadia Papagiannis noted that investors are sticking with hedge funds largely because of the perceived risk management of the alternative investment vehicles.

“This kind of choppy, volatile market environment is favorable for hedge funds in terms of flows, because investors don’t know here to turn or how to hedge their risks,” Papagiannis said. “So this is a good environment for hedge funds in terms of keeping clients and attracting new clients.”

Papagiannis noted that perhaps paradoxically, a bull market may be bad for hedge funds because investors will feel less need to hedge risk. “But for now, I still think investors hang onto hedge funds,” she said.

In contrast to single-manager hedge funds, hedge funds of funds are losing assets, continuing a trend started in the wake of the financial crisis of 2008-2009 that has seen investors demand more control and transparency, and lower fees. Hedge funds of funds in Morningstar’s database overall saw net outflows of $589 million in September and $2.5 billion in the 12 months ending in September.

Regarding hedge funds’ poor investment performance, Morningstar analyst Josh Charney said “hedge funds overall failed to fully participate in the equity market’s massive rebound in October. The abruptness of the market’s reversal, coupled with lingering bearish sentiment, likely caught some defensively positioned managers off guard.”

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