It all started so well. In February 2015, hedge funds posted their highest monthly gains (+2.13 per cent) for two years and there was an overall feeling of optimism in the air. As Preqin’s data reveals in its December Hedge Fund Spotlight, at the time 60 per cent of hedge fund managers felt that overall hedge fund performance in 2015 would exceed that of 2014.
Onwards into March, and further positive performance led to Q1 2015 being the best quarterly performance since Q4 2013, with the average hedge fund posting returns of +3.03 per cent.
And then, slowly but surely, things started to go awry. Such was the wave of volatility that swept through the markets in Q3 that by September most of the gains made had evaporated. Some will argue that hedge funds are supposed to come into their own when volatility rises, with stocks providing attractive spread levels as entry points and higher stock dispersion offering greater opportunity for stock pickers to generate pure alpha.
Through November 2015, the average equity hedge fund, according to Preqin, was up a modest 2.31 per cent and 2.23 per cent over the last 12 months. That might not sound exceptional but take a look at the S&P 500 Index and year-to-date it is down 0.38 per cent, and 1.54 per cent over 12 months.
So whilst it looks unlikely that hedge funds are going to exceed 2014’s performance, it’s important to keep things in context. It has been another year of challenging market conditions. Equity valuations are now starting to look ‘toppish’, and in the grand scheme of things, hedge funds have done exactly what they were meant to do; limit the downside and provide a diversification benefit to investor portfolios. They’ve done this, and some; on aggregate, equity hedge funds have outperformed the S&P by +2.69 per cent this year, and by +3.77 per cent over the last 12 months.
That should be taken as evidence of the important role that hedge funds play. Rather than set expectations for what this or that strategy, or the industry at large, should be achieving, it’s time that the narrative changed. Managers should come out and talk more about the function of hedge funds, and why they are important, not their individual performance. Investors still need educating on the fact that these are investment products that are designed to deliver returns when broader markets are falling.
They’ve done this in 2015. But rather than extoll the virtues of hedge funds, and focus on the positives, much is still made of performance. This is to miss the point. At a time when equity markets are likely to start to fall, or at least recalibrate to a level that cannot possibly reflect the enormous gains of the last five years, hedge funds are going to become even more important.
Hopefully in 2016 the hedge fund industry will seek to put more of a positive spin on things and stick up for itself.
With the US Federal Reserve finally making its first rate hike in a decade, and Europe still in the midst of loose monetary policy, there are going to be huge opportunities for global macro, equity long/short and relative value fixed income arbitrage managers in 2016 to exploit opportunities in an increasingly divergent global economy.
Volatility hedge funds with a long bias could be an interesting choice for investors in 2016 if markets become choppy again. The average volatility hedge fund returned +5.29 through November 2015, making it one of the best performing strategies.
It is interesting to note that whilst everyone rightly talks about the U.S. economic recovery, Europe-focused hedge funds had, through November 2015, outperformed US-focused hedge funds by quite some margin.
As Preqin highlights, the Preqin Europe Hedge Fund benchmark was up 5.57 per cent whereas the Preqin North America Hedge Fund benchmark was up a modest 1.29 per cent.
Back in June, the Greek debt crisis came perilously close to ripping apart the Eurozone project, causing Europe-focused hedge funds to lose -1.05 per cent that month.
Thanks to the agreed EUR86billion bailout being finalised in July, European hedge funds went on to quickly recover most of June’s losses, gaining 0.79 per cent.
This is a testament to the endurance of hedge fund managers.
If investors are willing to do their homework, Asia Pacific could continue to present some compelling investment opportunities in 2016. With gains of 7.11 per cent, Asia Pacific-focused hedge funds have had a very solid year, and are the best performing region.
If one looks at the three-year rolling Sharpe ratio for Asia-based hedge funds since 2012, up until April ’14 they lagged global hedge funds (All hedge funds in Preqin’s classification), with an approximate Sharpe ratio of 0.70.
Since then, however, the Sharpe ratio has climbed significantly and exceeded that of global hedge funds, climbing to 2.0 by October ’14 (no data to refer to for 2015).
What is perhaps even more telling is that the rolling Sharpe ratio of Asia-based funds vastly outperforms that of hedge funds with a focus on Asia but which are located outside the region: just 0.70 (approximately) compared to 2.0 (through the end of 2014).
If anyone wanted evidence that local managers with local insights are better placed than their global counterparts when it comes to trading Asian markets, this is it.
Despite the overall muted performance of global hedge funds in 2015, therefore, there are plenty of reasons to remain bullish when one digs into the details.
It’s time for the hedge fund industry to start a charm offensive and evolve the narrative.
