Barclays Prime Services Strategic Consulting has just completed its latest report entitled ‘Against All Odds – Hedge Fund Industry Developments and Implications for Growth’.
The report finds that although hedge funds have produced considerable excess returns since 1993, such levels have by and large plateaued since 2011, which may be at least partially due to managers’ reducing their risk appetite.
However, survey respondents indicated that they believe the size of the industry and macro conditions are more likely the reasons for recent hedge fund underperformance. The study finds that the industry, across various strategies, has achieved a CAGR over the past six years for hedge funds’ assets under management of between 9 per cent and 12 per cent, with a majority of the growth driven by an increase in average fund size as opposed to an increase in the number of funds.
The study also found that while the global stock of financial assets reached ~USD305 tn by year end 2015, hedge fund assets still only account for about 1 per cent, and writes that this suggests that the size of the industry probably is not the issue, whereas the size of individual hedge funds may be.
“Some of this underperformance by the largest managers may be attributable to the rise in crowded trades, which has increased substantially in recent years,” Barclays writes. “Furthermore, from the second half of 2015 onward, we observed considerable underperformance on the part of larger funds relative to smaller funds, a phenomenon that affected all strategies to varying extents.”
Recent times have seen macro conditions appear to have aligned against hedge funds the firm writes, as intra-stock correlation and dispersion have been at disadvantageous levels – making it challenging for hedge funds to produce alpha.
More than half of the investors the firm surveyed recently indicated that hedge funds did not meet their expectations over the last couple of years. “However, despite recent press to the contrary, the vast majority of investors we surveyed indicated that they are not pulling back wholesale from their hedge fund allocations,” Barclays writes.
“The commitment to hedge funds can at least partially be explained by the positive attribution HFs seem to offer after combining their risk-adjusted returns with their low correlation to indices. Furthermore, it appears that hedge funds are mitigating further underperformance by securing discounts, especially to management fees, though performance fees are discounted as well, particularly by strategies without capacity issues/netting risk.”
Barclays found that investors appear keen on increasing allocations to small and new managers in search of better returns and more flexibility on fees and terms. “Looking ahead, we expect hedge fund liquidations in 2016 to rise to 12 per cent from a recent historical average of 10 per cent, given the performance challenges of 2015 and early 2016. Additionally, if 2016 hedge fund performance continues at, or falls below, the annualised 1Q16 / 2H15 levels, the industry may face a reduction in AUM as net new flows are unlikely to be additive.”
In conclusion, the firm finds that based on investor input, they expect Systematic/Commodity Trading Advisors (CTA), Quant Equity, Distressed Credit, and
Equity Market Neutral strategies to attract investor interest and allocations over the next six to 12 months. Conversely, Event Driven and Equity Long / Short strategies appear to be the least in favour among investors at the mid-year.
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