By James Williams, Managing Editor, Hedgeweek – January proved to be a sluggish start for hedge funds. According to the Preqin All-Strategies Hedge Fund Benchmark, the average hedge fund returned 0.07 per cent although unlike James Bond, this was hardly likely to set investors’ hearts racing.
One strategy that stood out above all others was managed futures. The average CTA returned 3.10 per cent. That’s a respectable 14.72 per cent return over a 12-month period. By comparison, the average hedge fund, through January, had only returned 4.21 per cent. Macro strategies (0.84 per cent) and discretionary funds (0.48 per cent) fared reasonably well, but one sector that continued its malaise was emerging markets.
January’s negative returns of -1.21 per cent for emerging markets-focused hedge funds followed December’s loss of -1.20 per cent and represented the fifth consecutive monthly decline for the sector. This can largely be explained by the fact that a rising US dollar is causing potentially serious problems in countries like Brazil where companies have loaded up on US dollar-denominated debt and now face higher repayments; the Brazilian real has fallen 17 per cent against the greenback this year alone.
“Emerging markets had a difficult time at the end of 2014 heading into 2015. There was a lot of caution both from fund managers and investors in terms of investing in EM funds,” says Amy Bensted, Head of Hedge Fund Products at Preqin.
According to Hedge Fund Research, hedge funds with exposure to Russia and Eastern Europe declined -18.6 per cent in Q4 2014, rounding off the year with losses of -26.5 per cent on average.
What is perhaps surprising, therefore, is that by February this, performance of EM-focused hedge funds had turned a very sharp corner, locking in returns of 2.42 per cent according to Preqin’s figures. This suggests that emerging markets, as a whole, have a variety of idiosyncratic risks and opportunities; five months of losses could now lead to five consecutive months of gains, although it’s impossible to avoid the impact that the US dollar will likely have moving forward. In astrophysical terms, the US dollar has a similar gravitational impact on emerging markets as Jupiter has on the solar system.
Emerging market gains in February signalled a welcome return to form for hedge funds. Preqin’s data shows that the average hedge fund gained 2.49 per cent. This is the highest monthly gain since January 2013.
Equity strategies in particular stood out, gaining 3.28 per cent with event-driven strategies gaining 3.07 per cent.
“Performance will be important in 2015; 2014 was certainly a disappointing one for investors and they have cited this as something they will be playing close attention to over the year,” says Bensted. “Going into the year, fund managers were largely confident they’d be able to do better this year than the last and getting some high numbers on the board early in the year is obviously good news for the industry.”
Another strategy that did well in February was activism, the average fund gaining 3.22 per cent.
Bensted expects this to remain an interesting area in 2015 for institutional investors with the stomach to tolerate its risk/return profile. Activist funds have now delivered a respectable 7.23 per cent over the last 12 months; well in line with pension fund return targets. Given the longer-term investment horizon for activist funds, they have become a compelling option for institutions looking to establish liability-driven investments in their portfolio mix.
In just the same way that emerging market funds have experienced some volatility in returns this year, the same appears to be true of CTAs. Having continued their strong performance in January, February saw a reversal of fortunes as crude oil futures rebounded to around $52 per barrel; a sizeable bounce from end of January prices where WTI futures were trading at approximately $48 per barrel. This temporary reversal in oil prices appears to have hit CTAs with returns of just 0.20 per cent being recorded.
One of the most surprising trends that seem to have emerged this year is the strength of performance of UCITS funds. It’s not an overstatement to say that these regulated ‘lightweight’ versions of offshore hedge fund strategies hit a home run in January, in performance comparison terms, returning 1.31 per cent compared to 0.07 per cent.
These, after all, are strategies that are supposed to provide diluted returns for enhanced liquidity and lower volatility. Rather surprisingly, the average equity UCITS hedge fund generated 0.95 per cent, a clear improvement on offshore equity strategies, which returned -0.09 per cent. Even more striking, macro UCITS returned 2.99 per cent compared to 0.84 per cent.
This trend has continued on into February. The average performance of equity UCITS was 3.39 per cent according to Preqin, compared to 3.28 per cent for their offshore equivalents. On a YTD basis, UCITS funds are up 3.13 per cent compared to 2.52 per cent for offshore strategies. This is an encouraging sign, albeit a very short-term one, that regulated funds are actually capable of producing some solid returns.
“The performance of macro UCITS in January was quite unexpected. A lot of the reasons why investors continue to allocate to traditional hedge funds is to get superior returns and liquid alternatives, with their lower fees, have lower return expectations. But in recent times, alternative mutual funds have had almost as strong a performance as offshore hedge funds – and the figures for January are quite revealing.
“It will be interesting to see how this space progresses over the next few years. If liquid alternatives can consistently perform at a similar level to the offshore model we could see demand for these structures increase even further; it’s definitely a segment of the market to watch carefully,” says Bensted.
What would be interesting is to look into who is launching and managing these UCITS products and see if they tend to be versions of top quartile funds and whether there is any meaningful correlation.
One final insight is the performance of Asia Pacific hedge funds. This is a region that, from an AUM perspective, has never really kicked on in recent years. According to Preqin, Asia Pacific hedge funds total USD145bn in AUM; this represents a net inflow of USD33bn and a 29 per cent increase year-on-year between December 2013 and December 2014. All well and good, but industry assets have fluctuated around the USD200bn mark and never broken through.
Perhaps, as performance continues to improve and regional (as well as global) investors build faith in Asia Pacific fund managers, regional AUM will break the watershed and climb to USD300bn over the mid-term.
Looking at performance, Asia Pacific hedge funds have managed to outperform the wider hedge fund industry consistently, over 12-, 24- and 36-month periods, and indeed over a 5-year period. That’s a strong message, although as Preqin rightly points out in its Asia Pacific Hedge Funds report, this outperformance has tended to come with higher volatility.
Very briefly, the report finds that Asia Pacific hedge funds have outperformed the wider industry as follows:
12 months: 5.46 per cent versus 3.78 per cent
24 months: 11.60 per cent versus 7.93 per cent
36 months: 11.91 per cent versus 8.88 per cent
5 years: 8.44 per cent versus 7.74 per cent
One of the criticisms levelled at Asia Pacific hedge fund managers historically is that they did not employ robust enough risk management and active hedging: i.e. that they were simply too net long biased and harvesting what was essentially market beta, and not enough alpha. This caused many a long/short equity fund to hit the wall in 2008.
That seems to be changing, however. As Preqin points out: “The combined effect of stronger performance over most timeframes, and a drop in the amount of volatility exhibited by funds in the region, has led to Asia-Pacific-based funds, managed by fund managers located in the region, moving ahead of their all hedge funds counterparts, in terms of Sharpe ratio, since the end of 2014.”
Stronger performance coming back in February, and signs that Asia Pacific is outrunning the more established markets of New York and London have made from an interesting start to the year. The big question now is whether managers can navigate the markets successfully throughout the rest of 2015 and finally give their investors something to shout about. As central bank intervention in the US scales back, this should help to reduce equity market correlations and play to the strengths of the industry’s top stock pickers.
