Competition for alpha returns will thin, opening up opportunities for managers
By GENEVIEVE CUA 1November 2008
Returns from hedge funds and other actively managed funds are poised for a ‘golden age’ over the next six to 12 months, even as asset inflows slow considerably, says consultant Peter Douglas of GFIA.
Massive deleveraging in the financial system, heightened risk aversion and the bankruptcy of Lehman Brothers are only some of the events that have wreaked havoc on hedge fund returns. Still, while the HFRX Global Hedge Fund Index by Hedge Fund Research is down nearly 20 per cent in the current year-to-date, the MSCI World Index has fallen even more precipitously by 40 per cent.
The HFRX macro index has actually returned 1.15 per cent in the current year, but the convertible arbitrage index has suffered the deepest losses at minus 50 per cent.
Says Mr Douglas: ‘While we believe that the next three to six months will be extremely difficult for many hedge funds . . . the ensuing period is likely to be very fertile both for investment returns and new manager formation.
‘We saw first-hand how the Asian crisis of 1997-98 spawned a raft of opportunities for highly skilled professionals and in effect, kick-started the Asian hedge fund industry’s growth that accelerated to 2006. We believe this will happen again in 2009 but on a global scale.’
GFIA expects roughly US$2 trillion of hedge funds would lose a third of their assets, and US$4 trillion of investment bank trading assets will shrink by two-thirds. If the aggregate leverage in the system is assumed to fall from an estimated four times to 1.5 times, some US$24 trillion of alpha-seeking capital could shrink to US$4 trillion. This is an implosion of 85 per cent, he says.
All this, however, suggests that competition for alpha or value-add returns will thin, opening up opportunities for enterprising managers. ‘If you are still standing, and you know what you’re doing . . . you will be well compensated for taking risk. A lot of money will be scared off for quite some time, leaving much healthier returns.’
Up until recently, meagre returns from some strategies prompted hedge funds to tap large amounts of leverage to juice up those returns. But now the cost of credit has soared, and in any case, managers are still grappling with a flood of redemption orders.
‘Arbitrage opportunities will be wider for longer, and markets will offer far more persistent opportunities. With a lack of general appetite for equity market risk, indexed or quasi-indexed returns will be meagre, making the relative attraction of alpha returns much stronger,’ says GFIA.
Singapore-based hedge fund Artradis is already on the scent of opportunities. Reuters reports that it plans to raise US$500 million for a fund to invest in Asian convertible bonds. Artradis manages over US$4 billion in assets. The new fund will initially not deploy leverage and assets will be held in custodian accounts to minimise counterparty risk.
Mr Douglas expects that large hedge funds will become much larger, and morph into ‘new investment banks’. Already, some large hedge funds are acting as market makers, providing loan and risk capital directly to issuers and involving themselves in corporate strategy.
‘In essence the current very-large hedge funds will increasingly no longer be hedge funds, but large scale financial intermediaries and liquidity providers, and will drop off the hedge fund radar screens.’ The few mega-funds will be among the few able to run leveraged strategies, he adds.
Hedge fund attrition will rise, of course. But Mr Douglas expects start-ups to rise even if capital raising may be difficult. ‘We are likely to see . . . plenty of highly skilled professionals starting firms with few staff and few assets, producing very attractive returns for a few years before gradually attracting assets from initially shy investors. This is exactly the experience post-Asian crisis, which left a lot of excellent but dislocated talent looking for a home for their skills.’
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After the deluge, hedge funds may soar
Competition for alpha returns will thin, opening up opportunities for managers
By GENEVIEVE CUA
1November 2008
Returns from hedge funds and other actively managed funds are poised for a ‘golden age’ over the next six to 12 months, even as asset inflows slow considerably, says consultant Peter Douglas of GFIA.
Massive deleveraging in the financial system, heightened risk aversion and the bankruptcy of Lehman Brothers are only some of the events that have wreaked havoc on hedge fund returns. Still, while the HFRX Global Hedge Fund Index by Hedge Fund Research is down nearly 20 per cent in the current year-to-date, the MSCI World Index has fallen even more precipitously by 40 per cent.
The HFRX macro index has actually returned 1.15 per cent in the current year, but the convertible arbitrage index has suffered the deepest losses at minus 50 per cent.
Says Mr Douglas: ‘While we believe that the next three to six months will be extremely difficult for many hedge funds . . . the ensuing period is likely to be very fertile both for investment returns and new manager formation.
‘We saw first-hand how the Asian crisis of 1997-98 spawned a raft of opportunities for highly skilled professionals and in effect, kick-started the Asian hedge fund industry’s growth that accelerated to 2006. We believe this will happen again in 2009 but on a global scale.’
GFIA expects roughly US$2 trillion of hedge funds would lose a third of their assets, and US$4 trillion of investment bank trading assets will shrink by two-thirds. If the aggregate leverage in the system is assumed to fall from an estimated four times to 1.5 times, some US$24 trillion of alpha-seeking capital could shrink to US$4 trillion. This is an implosion of 85 per cent, he says.
All this, however, suggests that competition for alpha or value-add returns will thin, opening up opportunities for enterprising managers. ‘If you are still standing, and you know what you’re doing . . . you will be well compensated for taking risk. A lot of money will be scared off for quite some time, leaving much healthier returns.’
Up until recently, meagre returns from some strategies prompted hedge funds to tap large amounts of leverage to juice up those returns. But now the cost of credit has soared, and in any case, managers are still grappling with a flood of redemption orders.
‘Arbitrage opportunities will be wider for longer, and markets will offer far more persistent opportunities. With a lack of general appetite for equity market risk, indexed or quasi-indexed returns will be meagre, making the relative attraction of alpha returns much stronger,’ says GFIA.
Singapore-based hedge fund Artradis is already on the scent of opportunities. Reuters reports that it plans to raise US$500 million for a fund to invest in Asian convertible bonds. Artradis manages over US$4 billion in assets. The new fund will initially not deploy leverage and assets will be held in custodian accounts to minimise counterparty risk.
Mr Douglas expects that large hedge funds will become much larger, and morph into ‘new investment banks’. Already, some large hedge funds are acting as market makers, providing loan and risk capital directly to issuers and involving themselves in corporate strategy.
‘In essence the current very-large hedge funds will increasingly no longer be hedge funds, but large scale financial intermediaries and liquidity providers, and will drop off the hedge fund radar screens.’ The few mega-funds will be among the few able to run leveraged strategies, he adds.
Hedge fund attrition will rise, of course. But Mr Douglas expects start-ups to rise even if capital raising may be difficult. ‘We are likely to see . . . plenty of highly skilled professionals starting firms with few staff and few assets, producing very attractive returns for a few years before gradually attracting assets from initially shy investors. This is exactly the experience post-Asian crisis, which left a lot of excellent but dislocated talent looking for a home for their skills.’
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