Institutions To Continue To Flock To Hedge Funds

Terry Flanagan

Institutional investors are continuing to pile into the hedge fund space, in the elusive search for alpha, with some market participants believing that hedge funds globally could more than double their assets under management by 2016.

Despite hedge funds having endured a mixed 2012 so far, with year-to-date gains reduced to just 2.5% across all main strategies globally at the end of May, according to recent data from Chicago-based Hedge Fund Research (HFR), following on from overall losses of 4.8% in the whole of 2011, it appears that more and more institutional money will be allocated to hedge funds in the coming years—with European-focused hedge funds expected to attract a significant proportion of this.

Hedge funds, though, have managed to outperform most of the major market indices so far this year amid broad declines in global markets.

According to new research from Citigroup’s Prime Finance division, pension funds, endowments, foundations and other institutional investors are increasingly embracing the risk management and diversification that hedge funds offer, and that hedge funds are developing new products that are competing with traditional, long-only asset managers. These trends could contribute to a sharp rise in hedge fund assets over the next few years. The survey—based on interviews with 73 “industry participants” representing $821 billion in assets allocated, managed or under advisement—suggests that global assets invested in hedge funds could rise from $2.1 trillion today to over $5 trillion by 2016.

“We see a second wave of institutional allocations to hedge fund strategies, as well as new allocations to long-only strategies managed by hedge fund firms,” said Sandy Kaul, U.S. head of business advisory services at Citi Prime Finance, which provides trade execution, financing and business services. Citi says the first wave ran from 2003 to 2007 and saw institutions pour over $1 trillion into alternative assets.

Alan Pace, head of Citi Prime Finance, added: “While institutions have been allocating to hedge funds for years, such investments were considered to be on the periphery of core portfolio holdings. That is no longer the case. Today, with investors more focused on risk alignment within the overall portfolio, hedge fund allocations will play a central role in institutional portfolios in the years ahead.”

Meanwhile, the trend, in recent years, of hedge funds expanding into Asia in search of emerging market gains, may have peaked as opportunities in Europe, caused by the ongoing eurozone sovereign debt crisis, are beginning to appear on the horizon.

“There has been a lot of interest in Asia in the last couple of years,” Mark Parsonson, executive director of UK-based fund of hedge funds manager Liongate Capital Management, told Markets Media.

“There have been a couple of high-profile launches and successes, one manager started with $100 million in 2008 and now has over $2.5 billion. But like everywhere in the world it has been hard for many of these start-ups to raise money.

“Eurekahedge [a research firm] estimates that about three-quarters of the 300 or so Asian hedge funds started since 2009 have failed to increase assets significantly with nearly 50 of them liquidating. Some managers have even recently hired hedge fund managers in Asia who had set up on their own but were disappointed by performance or asset raising so have closed down funds.”

According to HFR, a provider of data and analysis to the alternative investment industry, the number of active Asia-focused hedge funds increased to 1,101 in the first quarter of this year, approaching the record number of 1,107 Asia-focused hedge funds set in the fourth quarter of 2007.

“There is still a lot of interest there,” said Parsonson. “Asia is in some respects less correlated than Europe and the U.S. and there are great trading opportunities out there but interestingly people have started to come back to Europe.

“We are seeing a lot of credit and distressed guys coming over from the U.S. and setting up or expanding in Europe. A lot of portfolio managers are spending a lot more time in Europe, some of them see it as potentially the next great investment opportunity.

“Depending on how things evolve, traditionally when you have seen volatility you have seen great opportunity so I think hedge funds are looking at Europe as maybe a potential next opportunity set rather than maybe Asia where the expectations were two to three years ago.”

HFR also revealed that new hedge fund launches globally for the first quarter of this year, which totaled 304, were at their highest level since the fourth quarter of 2007, when there were 298 launches, although liquidation levels were at their highest in two years. There were 232 funds that closed in the first quarter, the highest quarterly liquidation total since 240 funds closed in the first quarter of 2010.

“Innovative hedge funds are launching and finding opportunities as large financial institutions look to de-emphasize trading activities as a result of anticipated regulation, realized trading losses and enhanced risk management requirements,” said Kenneth J Heinz, president of HFR. “Execution and risk control are integral components of successful hedge funds and these have been greatly enhanced by the evolution of transparency in recent years. These powerful trends will continue to support launches of new hedge funds designed to monetize inefficiencies in capital markets as financial institutions adapt to new reporting, risk and trading requirements.”

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