(Pictured: Don A. Steinbrugge)
This year should be a good one for hedge fund managers. Surveys of investors in the past few months have been predicting bigger allocations to alternatives. But we’ve heard that before. The main reason this year will be good is that alpha is likely to have returned.
According to Agecroft Partners, a US third-party marketer and specialist consultant on alternatives, a decline in correlations within capital markets which began in the second quarter of last year will be accompanied by increased periods of volatility, as has been happening since the fourth quarter of last year.
“We expect this to continue as correlations and volatility levels move closer to historical averages,” says Don A. Steinbrugge, the managing partner of Agecroft, in his annual outlook for the hedge fund industry. Larger price movements make it easier for skilled and nimble hedge fund managers to add value.
Since 2009, most hedge fund returns have been driven by market beta due to rising equity and fixed income valuations in the US. This was enhanced by high correlations and low volatility. Long-only managers have therefore done well but, by comparison with hedge funds, this will change this year.
Steinbrugge said last week that the strategies which should do well this year include market neutral equities, arbitrage, global macro, CTAs, long/short equities and fixed income trading-oriented strategies.
“Not only will these strategies be in demand because of their increasing ability to generate alpha,” he said, “but also as a hedge to all-time high equity and fixed income prices.”
In other trends predicted in the Agecroft report:
> Smaller managers will continue to outperform – the high concentration of flows to the largest managers since the GFC has caused them to swell past their optimal asset levels.
> More hedge funds will shut down. Agecroft estimates there are a record 15,000 hedge funds in the world and their record number has reduced their average quality. Increased volatility will mean greater divergence of returns. The competitive landscape for small and mid-size managers is becoming increasingly difficult.
> Hedge fund industry assets will reach an all-time high. “We expect hedge fund industry assets to rise by US$210 billion, or 7 per cent [Agecroft estimates a total of $3 trillion in hedge fund assets, which is a little higher than most estimates], which was derived from a forecast of 2 per cent increase due to net asset flows and a 5 per cent increase from performance.”
> Founder’s share fee structure becomes mainstream for small hedge fund managers. The ‘founder’s share class’ of 25-50 per cent discount on standard fees began as a way to incentivize investors to invest on day one in a new fund. In the past couple of years it has been expanded to include a significant proportion of hedge funds with assets of less than $100 million. The trend adds downward pressure on hedge fund fees, which are also being squeezed by large institutional investors.
> ‘40 Act’ hedge fund marketplace becoming more competitive. The number of ’40 Act’ (retail and liquid) funds has ballooned. New entrants and smaller managers struggle unless they have a strong distribution partner.
Steinbrugge said that the AIFMD regulation in Europe, requiring hedge fund registration in individual countries, is hurting smaller managers disproportionately because of their lack of administrative resources. Yet European investors, historically, have been more willing to invest in smaller managers (than US investors) because of their higher return potential. So, the regulation is hurting European investors who are not seeing as many of the top emerging managers.