First quarter hedge fund inflows slump, says Lipper Tass report

First quarter inflows fell by 81 per cent or USD11.1bn from the fourth quarter figure of USD13.7bn, the fourth consecutive quarterly inflow decline as the credit crunch, liquidity fears and global growth concerns hit hedge fund performance particularly hard and investors appeared to pull back from the previous robust pace of inflows.

In US dollar terms, the biggest hedge fund sub-strategy inflows in the first quarter were experienced by event driven with USD4.65bn, global macro with USD3.82bn, and curiously convertible arbitrage at USD1.29bn, a total of USD9.76bn.

This was a significant change from the fourth quarter when directional and relative-value investment approaches were in favour and emerging markets, managed futures and multistrategy funds attracted combined inflows of USD9.1bn.

The biggest hedge fund sub-strategy outflows in the first quarter were experienced by long/short equity funds with USD7.03bn, multistrategy with USD1.53bn and fixed income arbitrage with USD59m.

As global equity markets suffered particularly badly in the first quarter, investors stepped up their redemptions, presumably in search of less volatile investment opportunities. The outflow for long/short equity was the first since the first quarter of 2003.

In terms of assets under management minus quarterly flows, the highest quarterly growth rates were experienced by dedicated short bias with 9.70 per cent, convertible arbitrage with 3.98 per cent and global macro with 3.15 per cent. The three lowest strategies for quarterly growth were long/short equity, which lost 1.56 per cent of its assets, multistrategy funds which lost 0.60 per cent and fixed income arbitrage which saw a decline of 0.08 per cent.

The first quarter pace of global hedge fund net inflows was just 0.18 per cent, compared with 1 per cent in the previous quarter and the 2.62 per cent average quarterly growth exhibited since January 1994. Three out of 10 hedge fund sub-strategies posted a net quarterly outflow.

In absolute terms, the performance of the Credit Suisse Hedge Fund Index was miserable, with first quarter performance of 2.01 per cent the lowest since the third quarter of 1998, when the broad hedge fund index saw a decline of 8.87 per cent.

While this outpaced equity indices such as the S&P 500 TR Index (-9.44 per cent) and the MSCI World Index US TR (-8.95 per cent), the Lehman Aggregate Bond Index posted a return of 6.63 per cent.

Performance was affected by excessive market uncertainty due to illiquidity in credit markets, falling real estate prices depressing consumer and corporate sentiment, rising mortgage delinquencies, lower corporate earning estimates and growing fears of stagflation. Investor risk appetite was sharply reduced and the first quarter was notable for the scale and depth of deleveraging by banks and hedge fund managers..

The Federal Reserve reacted to the threat of recession, liquidity issues in the credit markets and the threat of insolvency to Bear Stearns by slashing the Fed funds rate three times by a combined 200 bps between January 22 and March 18. It also instituted new collateral arrangements for borrowing institutions including broker-dealers to access the previously  little-used discount window facility.

Equity markets suffered steep declines that negatively impacted hedge funds, as US equity markets fell across all market capitalisation bands. Growth stocks were damaged by a 15 per cent drop in the technology sector, while the best performing sectors of consumer staples, materials and industrials were down by between 2 and 4 per cent.

International equities also suffered with India down 25 per cent and China down 20 per cent; only Argentina, Mexico and Peru posed positive performance. The first quarter also saw a number of high-profile hedge fund liquidations including Peloton, Endeavour and Sailfish

Bond investors benefited from a flight to quality as steepening trades performed best in the wake of aggressive rate cuts by the US Federal Reserve yield and the spread between two- and 10-year Treasuries declined from 0.9 per cent at the start of the quarter to 1.8 per cent by the end of March.

The larger decline at the front end of the yield curve allowed intermediate-term Treasuries to outperform the long end of the curve. Non-investment grade bonds fell 3 per cent on fears of a recession, while high-yield spreads over 10-year Treasuries widened from 5.6 to 7.5 per cent. The spread widening did not follow any discernable increase in default rates.

Over the first quarter, hedge fund inflows largely followed the pace and direction of investment returns. The best performing sub-strategies were managed futures, dedicated short bias and global macro, which returned 10.42, 9.83 and 6.88 per cent respectively.

The worst performing strategies were convertible arbitrage and fixed income arbitrage, which lost 7.64 per cent and 6.78 per cent for the quarter respectively, the worst in their history. Emerging markets recorded a 4.20 per cent decline as fears of recession hit domestic demand-oriented names across most regions and countries.

Long/short equity returned minus 4.10 per cent in its worst quarter since early 2001, while multistrategy funds, which often dabble in a relative value investment approach, fell by 3.92 per cent for their worst quarter in nearly 14 years.