Allocations to hedge funds have slowed to their lowest level since the fourth quarter of 2005 as volatile financial markets prompt investors to adjust strategy exposures, according to Chicago-based industry data provider Hedge Fund Research.

Investors allocated USD12.5bn of new capital to the industry in the second quarter, bringing total capital inflows for 2008 to around USD29bn - the lowest total for the first six months of a year since 2003, when the industry attracted USD28.3bn from January to June.

By comparison, the first six months of 2007 saw inflows totalling some USD118bn, in a year that ended with a record total of USD194.5bn. Inflows for the second quarter of 2007 amounted to USD58.7bn.

In what appeared to reflect continued concern over credit exposure, investors withdrew more than USD3.6bn from relative value funds, but allocated nearly USD7bn in fresh capital to macro strategies.

Macro has continued to perform well through the financial turmoil of the past year, with the HFRX Macro Index gaining more than 14 percent in 2008 up to mid-July. Macro strategies as a whole have benefited broadly from persistent trends in commodities and currencies, as well as from lack of direct exposure to credit weakness.

Despite the volatility, total industry capital increased by around USD56bn during the second quarter, with the broad-based HFRI Fund Weighted Composite Index gaining more than 2.25 percent, partially offsetting its decline in the first quarter.

Total capital under management at the end of June stood at USD1.931trn, according to HFR. Up from USD1.875trn at the end of the first quarter. Investors also continued to access the hedge fund industry through funds of hedge funds, allocating nearly USD9bn during the quarter and boosting fund of hedge funds assets to USD825.9bn from just over USD800bn at the end of March.

Among sub-strategies, equity hedge fundamental growth saw the largest quarterly inflow with USD6.7bn, while two macro sub-strategies, discretionary thematic and systematic diversified, also took in significant new capital, with inflows of USD6.2bn and USD5.2bn respectively.

Relative value multistrategy saw the largest outflow, with investors pulling almost USD8bn from these funds. In interesting opportunistic counter-trend, HFR says the corporate fixed income, convertible arbitrage and asset-backed sub-strategies all saw positive capital flows.

Dedicated short selling strategies again found favour with investors, gaining more than 8 percent in June to advance more than 11.6 percent so far in 2008. Judging by ongoing policy debate on both sides of the Atlantic, the strategy remains a focus for investors.

Capital raised by new firms (USD6.7bn) exceeded that allocated to existing firms (USD5.8bn) during the second quarter. More than 100 percent of the net new capital allocated to existing firms went to those with more than USD5bn under management; firms managing less than USD5bn experienced net redemptions.

'There were some interesting allocation preferences in response to performance volatility in the second quarter,' says HFR president Kenneth J. Heinz. 'In some cases, investors allocated opportunistically to areas of weak performance (emerging markets and growth equity), while in others they reduced capital in response to negative performance (relative value) and allocated to areas of strength (macro).

'Investors allocated to established funds and funds of funds but also funded several new launches in the quarter. The marketplace appears to be expecting a volatile environment and portfolios are being positioned to benefit from this.'

HFR's data is based on more than 12,000 funds tracked historically by the firm, including more than 7,600 funds reporting as part of the HFR Database subscription product. Founded in 1993, Chicago-based HFR Group is a provider of hedge fund data, research, indexation and asset management products and services, including the HFRI and HFRX indices of hedge fund industry performance.


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