Dearth of positive returns could further dampen wealthy individuals’ appetite for hedge funds, triggering massive redemptions.
By Genevieve Cua 31 January 2009
Hedge fund strategies are expected to continue to post negative returns this year, even as managers hunker down with reduced leverage and mull new fee structures to attract investors.
Aureliano Gentilini, Lipper global head of hedge fund research, says the dearth of absolute performance will be one of the key issues that hedge funds will grapple with this year and even into 2010. Lipper, of the Thomson Reuter group, has just published a survey of managers which gives a snapshot of returns outlook as well as other key issues including funds’ cash allocations and prime brokerage arrangements.
The dearth of positive returns could further dampen wealthy individuals’ appetite for hedge funds, although institutions are still exploring increased exposures, say sources.
‘One of the main themes for 2009 will be the ability of hedge funds to post absolute performance. The industry will still face massive redemptions from scandals and the lack of confidence. But I’d say most of the redemptions will be by high net worth individuals. Institutions are still pouring money into alternative investments,’ says Mr. Gentilini. Institutions appear to be more inclined to consider single manager funds rather than fund of hedge funds.
The survey was conducted in November, and involved 33 respondents from both single strategy funds and funds of hedge funds. The firms represent a combined US$92 billion of assets. The median assets under management was US$340 million, compared to US$861 million in 2007.
The survey was conducted after a very difficult September and extremely high volatility in October - factors that may have contributed to ‘potentially biased’ responses with respect to performance and expectations, says the report.
2008 has gone down as the worst year in hedge fund history where extreme market stress sparked an avalanche of redemptions, which further exacerbated plunging markets. Hedge Fund Research (HFR) has estimated that the industry’s assets under management shrank last year from US$2 trillion to US$1.4 trillion. HFR’s global hedge fund index shows a 23 per cent loss for 2008. Based on the Credit Suisse/Tremont AllHedge Index, 2008 registered a loss of 25 per cent, with only one strategy - managed futures - generating a positive return of 19.8 per cent. Hedge fund returns, of course, look good against the general carnage as S&P 500 dropped 37 per cent last year, and Asia and the emerging markets fell between 50 and 70 per cent.
In any case, on top of the losses, private investors were also dismayed by ‘gates’ that were imposed by funds to limit redemptions, even by funds of hedge funds which prided themselves in offering a more liquid access to the traditionally fairly opaque asset class. The Madoff scandal, where some funds of hedge funds turned out to have invested all their assets into the alleged Ponzi scheme, has also raised questions on the due diligence that such funds are supposed to have done, as well as their fees. Funds of hedge funds typically charge a one per cent annual fee and 10 per cent performance fee, on top of their underlying funds’ fees. But scrutiny on all fees will intensify with the bear market.
Mr. Gentilini believes a fund of hedge fund that is merely geographically diversified may not survive. ‘Generally speaking, the multi-strategies model offering a diversified investment approach certainly hasn’t lived up to its billing, and many of these firms will suffer heavy redemptions in the coming quarters,’ he says.
Ananth Shenoy, Citi Asia Pacific (global wealth management) head of alternative investments, says the bank’s clients can access both single strategy and funds of hedge funds. On the latter, he says: ‘A number of them position themselves as trying to manage downside risk with one-third of the volatility in the market. They seek reasonable returns with a target of Libor plus 300 basis points or so. This positioning warrants a place in the strategic asset allocation of clients and this has all been questioned in the last six months...
‘FOHFs ended the year with marked to market loss of 20 to 23 per cent, higher than most people expected. That was a disappointment...But last year was a case of a deep shock to the entire financial system and the hedge fund industry has done reasonably well when compared to the performance of the underlying markets in which they participate.’
Based on the survey, managers’ top strategy picks for 2009 were distressed securities, global macro, managed futures and long/short equity. Based on the Lipper TASS database, 75 per cent of managed futures funds posted positive returns for 2008, with nearly two-thirds posting returns above 10 per cent. The dispersion of returns for the strategy, however, was wide. The highest return recorded was 136 per cent and the worst, minus 88 per cent.
The survey reflects what appears to be markedly higher levels of manager turnover among funds of hedge funds. There was also a significant shift in cash allocations towards higher percentages of over 10 per cent, which probably reflects the panic selling and deleveraging that followed September’s collapse of equity markets.
On leverage ratios, most managers have scaled down leverage to less than two times. Normally the average leverage ratio has ranged between less than two times and up to four times. Mr. Gentilini says the reduction in leverage reflected a more cautious approach. Interestingly, almost half the managers who had indicated a leverage ratio in the lowest bracket of less than two times, expected an increase in the ratio in 2009 - of a ‘low magnitude’.
On fees, Mr. Gentilini believes that the cost structure particularly for firms with less than US$250 million in assets - is breaking down. The bulk of large single strategy funds is now well below their high water marks. Hedge funds typically levy an annual fee of 2 per cent of assets and a performance fee of 20 per cent. A high water mark would apply to the latter, which means that it cannot be charged unless the fund beats its previous high.
As performance fees comprise the bulk of a fund’s earning power, many funds may be forced to close. Some funds are reportedly considering cutting fees and imposing longer lock-up periods. Among the managers polled, over 30 per cent expected to reduce or remove management fees, and 15 per cent to do so for performance fees to retain investors.
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Hedge funds still bleeding
Dearth of positive returns could further dampen wealthy individuals’ appetite for hedge funds, triggering massive redemptions.
By Genevieve Cua
31 January 2009
Hedge fund strategies are expected to continue to post negative returns this year, even as managers hunker down with reduced leverage and mull new fee structures to attract investors.
Aureliano Gentilini, Lipper global head of hedge fund research, says the dearth of absolute performance will be one of the key issues that hedge funds will grapple with this year and even into 2010. Lipper, of the Thomson Reuter group, has just published a survey of managers which gives a snapshot of returns outlook as well as other key issues including funds’ cash allocations and prime brokerage arrangements.
The dearth of positive returns could further dampen wealthy individuals’ appetite for hedge funds, although institutions are still exploring increased exposures, say sources.
‘One of the main themes for 2009 will be the ability of hedge funds to post absolute performance. The industry will still face massive redemptions from scandals and the lack of confidence. But I’d say most of the redemptions will be by high net worth individuals. Institutions are still pouring money into alternative investments,’ says Mr. Gentilini. Institutions appear to be more inclined to consider single manager funds rather than fund of hedge funds.
The survey was conducted in November, and involved 33 respondents from both single strategy funds and funds of hedge funds. The firms represent a combined US$92 billion of assets. The median assets under management was US$340 million, compared to US$861 million in 2007.
The survey was conducted after a very difficult September and extremely high volatility in October - factors that may have contributed to ‘potentially biased’ responses with respect to performance and expectations, says the report.
2008 has gone down as the worst year in hedge fund history where extreme market stress sparked an avalanche of redemptions, which further exacerbated plunging markets. Hedge Fund Research (HFR) has estimated that the industry’s assets under management shrank last year from US$2 trillion to US$1.4 trillion. HFR’s global hedge fund index shows a 23 per cent loss for 2008. Based on the Credit Suisse/Tremont AllHedge Index, 2008 registered a loss of 25 per cent, with only one strategy - managed futures - generating a positive return of 19.8 per cent. Hedge fund returns, of course, look good against the general carnage as S&P 500 dropped 37 per cent last year, and Asia and the emerging markets fell between 50 and 70 per cent.
In any case, on top of the losses, private investors were also dismayed by ‘gates’ that were imposed by funds to limit redemptions, even by funds of hedge funds which prided themselves in offering a more liquid access to the traditionally fairly opaque asset class. The Madoff scandal, where some funds of hedge funds turned out to have invested all their assets into the alleged Ponzi scheme, has also raised questions on the due diligence that such funds are supposed to have done, as well as their fees. Funds of hedge funds typically charge a one per cent annual fee and 10 per cent performance fee, on top of their underlying funds’ fees. But scrutiny on all fees will intensify with the bear market.
Mr. Gentilini believes a fund of hedge fund that is merely geographically diversified may not survive. ‘Generally speaking, the multi-strategies model offering a diversified investment approach certainly hasn’t lived up to its billing, and many of these firms will suffer heavy redemptions in the coming quarters,’ he says.
Ananth Shenoy, Citi Asia Pacific (global wealth management) head of alternative investments, says the bank’s clients can access both single strategy and funds of hedge funds. On the latter, he says: ‘A number of them position themselves as trying to manage downside risk with one-third of the volatility in the market. They seek reasonable returns with a target of Libor plus 300 basis points or so. This positioning warrants a place in the strategic asset allocation of clients and this has all been questioned in the last six months...
‘FOHFs ended the year with marked to market loss of 20 to 23 per cent, higher than most people expected. That was a disappointment...But last year was a case of a deep shock to the entire financial system and the hedge fund industry has done reasonably well when compared to the performance of the underlying markets in which they participate.’
Based on the survey, managers’ top strategy picks for 2009 were distressed securities, global macro, managed futures and long/short equity. Based on the Lipper TASS database, 75 per cent of managed futures funds posted positive returns for 2008, with nearly two-thirds posting returns above 10 per cent. The dispersion of returns for the strategy, however, was wide. The highest return recorded was 136 per cent and the worst, minus 88 per cent.
The survey reflects what appears to be markedly higher levels of manager turnover among funds of hedge funds. There was also a significant shift in cash allocations towards higher percentages of over 10 per cent, which probably reflects the panic selling and deleveraging that followed September’s collapse of equity markets.
On leverage ratios, most managers have scaled down leverage to less than two times. Normally the average leverage ratio has ranged between less than two times and up to four times. Mr. Gentilini says the reduction in leverage reflected a more cautious approach. Interestingly, almost half the managers who had indicated a leverage ratio in the lowest bracket of less than two times, expected an increase in the ratio in 2009 - of a ‘low magnitude’.
On fees, Mr. Gentilini believes that the cost structure particularly for firms with less than US$250 million in assets - is breaking down. The bulk of large single strategy funds is now well below their high water marks. Hedge funds typically levy an annual fee of 2 per cent of assets and a performance fee of 20 per cent. A high water mark would apply to the latter, which means that it cannot be charged unless the fund beats its previous high.
As performance fees comprise the bulk of a fund’s earning power, many funds may be forced to close. Some funds are reportedly considering cutting fees and imposing longer lock-up periods. Among the managers polled, over 30 per cent expected to reduce or remove management fees, and 15 per cent to do so for performance fees to retain investors.
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