By James Williams - Depending on which figures you refer to, the US hedge fund market did pretty okay in 2010: not great, but steady. Morningstar’s US Equity Hedge Fund Index rose 13.4 per cent. According to Hedge Fund Research, hedgies gained 10.4 per cent. When you consider, however, that the Standard & Poor’s 500 gained 15.1 per cent, and the Dow Jones 11 per cent, just how much “alpha” did US hedge funds really capture?
One thing is certain: North America in 2010 was the most successful hedge fund region. Scan Bloomberg’s recently published “100 Top-Performing Large Hedge Funds 2010” and you’ll see that US hedge fund managers dominate the list. There were some truly exceptional fund performances: Structured Portfolio Management took top spot, its Structured Service Holdings Fund, which trades mortgage backed securities, generating gains of 49.5 per cent.
Ray Dalio’s Bridgewater Associates – America’s biggest hedge fund with approximately USD58.9billion in assets – took third spot with its macro-focused Pure Alpha II Fund up 39 per cent. Bridgewater’s assets grew by USD15.3billion in 2010 – that’s practically 10 per cent of Asia’s total hedge fund AUM.
Other strong performers included AQR Capital Management’s Global Risk Premium Fund (+27.3 per cent), Pine River Capital Management’s Nisswa Fixed Income Fund (+27 per cent) and Daniel Loeb’s Third Point Offshore Fund (+25.2 per cent).
Breaking things down by strategy reveals that Distressed Debt was last year’s best performing strategy in the US, returning +26.66 per cent. “With rising equity prices, declining interest rates, there was an increased search for high-yield products,” BarclayHedge Chairman Sol Waksman (pictured) tells Hedgeweek. “That given, it was hard to find a strategy that didn’t make money last year.”
Asked whether he was surprised at distressed debt funds like Cerburus Institutional Partners Series IV (+20 per cent) performing well, Waksman says: “When hedge fund managers started buying up these securities, interest rates were higher, there were tremendous fears in the markets and there was a need for liquidity."
Falling volatility in the markets saw a fair degree of correlation in US hedge fund strategies, with CTA/Managed Futures (+14.44 per cent), Equity L/S (+13.11 per cent), Event-Driven (+18.79 per cent), Relative Value (+13.82 per cent) and Fixed Income (+14.10 per cent) all doing well. The widest dispersion, between the Equity long/short and Event Driven strategies, was less than 6 per cent. “Performance dispersion by strategy was relatively tight between the best and worst performers,” Hedge Fund Research President Ken Heinz tells Hedgeweek, “so it's difficult to say that one surprised me more than any of the others.”
This suggests that generating uncorrelated alpha amongst managers is getting harder, and explains why stellar fund managers like Bridgewater’s Dalio are attracting significant tickets. US Macro strategies delivered -0.50 per cent in 2010, yet Pure Alpha II, as mentioned, rocketed +44.8 per cent. This came as a result of Dalio being bearish on the US economy and bullish on the yen and gold. The fund uses a global macro strategy to make bets on currencies, debt, equities and commodities.
Dalio declined to give Hedgeweek any comment on market conditions, although speaking recently on CNBC he said that US stocks were still “comparatively cheap” and that he believed the US dollar’s role would diminish as a dominant world currency to one of a few over a “gradual time”. HFR’s Heinz says that last year was one in which “macro considerations overwhelmed a real improvement in corporate earnings”.
“Given the highly correlated markets that persisted for much of last year, I’d say that 2010 was a tough year for anyone looking for alpha,” says Sebastian Ceria, founder and CEO of Axioma, a New York-headquartered portfolio analytics and optimisation firm. “When correlations are high, opportunities are harder to find.” Ceria adds that despite the difficulties, the fact that assets under management climbed 20 per cent year-on-year to USD1.92trillion by end-2010 suggested that hedge funds “remained attractive to investors”.
But not all investors are lucky enough to place their assets with best-of-breed firms like Bridgewater, Och-Ziff, Soros Fund Management etc. And with a heavy regulatory cloud descending on the industry, will investors be happy paying high fees for largely beta returns? Bradley H. Alford, CIO at Atlanta-headquartered Alpha Capital Management, was quoted as saying recently: “A client told me the other day that paying these ridiculous fees for single-digit returns, then worrying about these investigations — it’s just not worth it.”
With over 80 per cent of assets flowing into funds with USD5billion or more in AUM in 2010, some industry commentators have suggested that fund performance is being suffocated by the sheer size of funds.
After Bridgewater, and J.P. Morgan Asset Management (USD45.5billion), Paulson & Co ranks third with an estimated USD36billion in AUM. Legendary manager Paulson earned himself a rather respectable USD5billion in 2010, but up until August 2010 his flagship Advantage Fund, which uses an event arbitrage strategy, was down 11 per cent. DealBook wrote that Paulson was taking heat from investors who claimed his funds were too big to manage effectively. But thanks to a last-minute blockbuster performance in the last three months of 2010, the fund ended up 17 per cent for the year to cap a remarkable turnaround.
Even though this was only 2 per cent better than the S&P 500, it illustrated Paulson’s genius. Hartford Financial Services, MGM Resorts and Boston Scientific were believed to be key stock performers.
Other US fund managers that did well in the Event-Driven space, according to Hedgeweek’s Global Fund Data website (www.globalfunddata.com ), were Third Point’s Offshore Fund (+25.2 per cent) and the Pershing Square International Fund managed by Bill Ackman (+28.22 per cent). “Event-driven was a good year and above the board,” says Waksman. “Distressed and merger arbitrage, the whole merger strategy opened up last year. Lots of corporations are sitting on cash and thought it was better to buy than build.”
QE2 has helped boost the US equity markets but when will this translate into more employment opportunities being created? Unemployment is still around the nine per cent mark. Growth has been based on artificial foundations and it’ll be interesting to see what happens when stimulus is pulled back, given that the S&P 500 has hiked up 25 per cent since September.
Certainly 2010 saw some strong performances from equity long/short managers, with Philippe Laffont’s Coatue Management returning +18 per cent. Laffont established the fund back in ’99 and is more of a contrarian, his “dare to be different” mantra meaning that directional bets are typically avoided, with under-the-radar stocks the more preferred choice. Technology, media and telecoms sectors are the main focus of the fund with stocks like Apple making up the long side of the book.
Other successful equity long/short managers included Jacob Gottleib’s Visium Balanced Offshore Fund, which returned +16.4 per cent according to Bloomberg, with a recent filing showing that healthcare was the primary focus making up over 70 per cent of the portfolio. Robert Karr’s Joho Partners Fund also did well, gaining 13.9 per cent. According to Gurufocus, Estee Lauder shares in the fund increased 153 per cent making it the fund’s second largest weighting behind New Oriental Education and Technology Group.
Waksman admits he was bearish on US equities last year and was surprised by the extent of the rally. “Global rallies in equity and fixed income markets in 2010 and compression of credit spreads,” says Waksman, “were the main drivers of returns across all hedge fund strategies other than short equities.”
With US Treasuries rallying last year in a “flight to safety” response to the unfolding catastrophe that befell Greece and the Eurozone at large, there were big opportunities for the credit and relative value hedgies. David Tepper’s Appaloosa Investment, a global credit fund, was up 20.9 per cent whilst his Thoroughbred fixed income fund gained 18.6 per cent. Another top US performer was Jeffrey Talpins’ Element Capital fund, whose fixed income arbitrage strategy notched up 17.3 per cent. Tepper was quoted in the press as saying: “It was an interesting year where you had to have a couple of gut checks. If you had those gut checks, looked around and made the right decisions, you could make some money.”
Relative Value funds gained 13.82 per cent overall. As mentioned, Structured Service Holdings, an MBS-focused fund, had a phenomenal year. Also performing well was AQR Capital Management’s AQR Delta Fund (+12.4 per cent). HFR’s Heinz believes that RV strategies were the biggest beneficiaries of falling rates over the first 10 months of 2010 but adds: “I don’t expect the same to occur in 2011.”
With EU sovereign debt concerns, there were plenty of fixed income RV opportunities (sovereign arbitrage) as well as those in global currencies. “An analysis we did of the Chinese currency situation last year illustrated that those investors equipped with an understanding of the dynamics of that situation stood to benefit handsomely,” says Axioma’s Ceria. “The answers were there, if you knew where to look.”
US hedgies did well enough in 2010. With institutional allocations expected to increase in 2011, managers will be under intense pressure to seek out alpha, but if past performance is a useful guide, 2011 should prove to be another year of steady performance for the industry.