The latest report from Hedge Fund Research reveals that the hedge funds sector ended 2004 with nearly USD 1 trillion in assets under management.
Growth in 2004 was fuelled by USD 79.6 billion growth in assets in Q4, including USD 27 billion in new money, ranking as the largest quarterly asset increase since HFR started tracking the industry eleven years ago.
The Distressed Securities and Emerging Markets categories continue to set the performance pace with Multi-Strategy categories- such as Event Driven and Relative Value Arbitrage - gaining more traction; Fund of Hedge Funds expansion hitting a plateau and Macro taking a breather.
HFR;s year-end analysis for 2004 shows that for the year hedge funds returned 8.9% to investors, attracted USD 73.6 billion in net inflows, and expanded by nearly 19% to USD 972.6 billion in assets under management.
Although these results are more moderate than the torrid pace seen in 2003 (19.6% performance return and 31% total growth), 2004 was notable for its rapid recovery from a mid-year slowdown and steady performance in nearly all fund categories. According to HFR, the current trajectory makes it highly likely that that the industry will eclipse USD 1 trillion in Q1 2005.
In particular, the annual results were energized by an extremely strong Q4 that brought a solid finish to a year that had experienced negative to flat returns in Q2 and Q3, and tepid mid-year asset flows. The USD 79.6 billion expansion of assets in Q4, made possible by a solid 5.3% industry-wide quarterly performance gain along with $27 billion in inflows qualifies as the largest quarterly expansion yet seen by HFR.
Joshua Rosenberg, President of HFR, said: "Apart from the more than USD 152 billion increase in assets under management from year end 2003, the big story in hedge funds in 2004 may be the growth in popularity of multi-strategy funds. At a time when diversification is increasingly sought by investors, it is not surprising that Relative Value Arbitrage and Event Driven funds, which employ a greater range of investing tools than typical single strategy-focused funds, collectively attracted nearly USD 22 billion in new money in 2004.
A close examination of the data available in the Q4 2004 HFR report, as well as data from the entire year, reveals a number of interesting trends from across the 33 distinct categories of hedge funds that HFR tracks.
Hedge funds trends in 2004
The Event Driven category, also known as "corporate life cycle" investing, which looks for opportunities created by significant transactional events, such as spin-offs, mergers and acquisitions, bankruptcy reorganizations, recapitalizations and share buybacks, grew by 28% in 2004, ending the year with USD 128.6 billion in assets, (second in size only to the Equity Hedge category). For the year, the sector attracted just over USD 10 billion in new capital and returned 14.2% to investors (catalyzed by a vigorous 7.8% return in Q4).
The USD 46.3 billion Distressed Securities category, which makes investment in distressed firms through bank debt, corporate debt, trade claims, common stock, preferred stock or warrants, returned an impressive 18.6% for the year (including 7.7% in Q4 alone) and attracted USD 6.6 billion in new funds, reversing a USD 2 billion outflow in 2003. Total asset size in the category grew by 30% from its year-end 2003 level of USD 35.5 billion.
Although its return was roughly half of its 39.8% performance in 2003, the USD 32 billion Emerging Market category continued to set the pace in 2004, returning 19.0% to investors. Returns were largely driven by investment in China as well as Eastern European-focused funds which were up more than 32% on an annualized basis.
The multi-strategy Relative Value Arbitrage category, which attempts to take advantage of relative pricing discrepancies between instruments including equities, debt, options and futures, attracted USD 11.3 billion in new capital in 2004 (more than any other category except Equity Hedge). The sector, which saw a 5.3% return on investment in 2004, expanded by 23% to USD 121.5 billion in assets and is now the third largest hedge fund sector (after Equity Hedge and Event Driven).
The mammoth USD 285.9 billion Equity Hedge category expanded by 18% over the course of the year, and remains by far the largest category. In 2004, the category rallied strongly in Q4 (5.4%) to return 7.4% for the year. Combined with USD 19.1 billion in yearly inflows, the category maintained its relative size with respect to the remainder of the industry.
Although the USD 358.6 billion Fund of Funds sector expanded by 22% in assets under management over the course of the year, the pace was more moderate than in prior years. In fact, data indicates that the percentage of total hedge fund assets controlled by Funds of Funds may have reached a plateau of around 36%.
The USD 107.4 billion Macro Fund category, which is characterized by leveraged bets on anticipated price movements of global stock markets, interest rates, foreign exchange and physical commodities, picked up inflows of only USD 5.3 billion over the year, a steep drop off from the USD 28.1 billion inflow seen in 2003. On a performance basis, the category returned a lackluster 4.1% to investors.
Categories that declined in size include: the USD 14.5 billion Merger Arbitrage sector, which through modest outflows and poor performance lost just less than 1%, and the USD 3.6 billion Market Timing category that lost just over 7% when large outflows were not overcome by 4.7% performance return.