07.15.2014
By Terry Flanagan

Low Bond Yields Drive Hedge-Fund Flows

Persistently low interest rates are helping drive capital flows into hedge funds, as institutional asset owners such as pension plans, foundations and endowments seek higher returns than are offered by bonds, without taking undue risk.

Don Steinbrugge, managing partner at hedge-fund marketer Agecroft Partners, noted that pensions typically categorize hedge funds in a separate investment ‘bucket’, which can generate annual returns in the range of 4% to 7.5% with low risk. The benchmark 10-year U.S. Treasury note currently yields about 2.5%.

“As long as 4-7% is higher than 2.5%, you’re going to see more flows into hedge funds,” Steinbrugge told Markets Media.

But given as large institutional asset owners can be slow-acting, the shift is “glacial,” Steinbrugge said. “It’s a long-term trend. The only thing that will cause it to change is if interest rates go up.”

Net flows into global hedge funds totaled $65.3 billion in the first half of 2014, in line with $67 billion of inflows in the year-earlier period, according to Eurekahedge. Flows have remained strong despite mixed investment returns and underperformance compared with the Standard & Poor’s 500.

But while media reports typically highlight the comparison with the S&P, Steinbrugge said that’s not the proper benchmark for most hedge funds, and they have done reasonably when juxtaposed with the more appropriate Russell 2000.

Credit hedge funds including distressed debt have performed well, as has activist strategies, Steinbrugge said. Commodity trading advisors (CTAs) have underperformed, as have global macro strategies, as many managers were wrong about bond yields and volatility.

While Steinbrugge said 80% of hedge funds are “not very good,” the ones that are good generate attractive risk-adjusted return.

“There’s a misconception about how risky hedge funds are,” Steinbrugge said. “People forget that there’s real risk in 30-year Treasuries, long-equity portfolios, and even money markets where your purchasing power goes down every year.”

 

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