Friday, June 27, 2014

A Hedge Fund Love Affair?

Halah Touryalai of Forbes reports, Everybody Loves Hedge Funds, Assets Hit Record $3 Trillion:
Love ‘em or hate ‘em, the world of hedge funds is only getting bigger.

The industry saw assets surpass $3 trillion in May for the first time ever.

That’s according to hedge fund database, eVestment, which notes the new record exceeds the asset peak from 2008.

It’s been a particularly strong year for hedge funds. In May alone, $22 billion of new capital was added bringing year-to-date flows to $93.3 billion. That’s the strongest start to a year since 2007.

The industry’s growth is part of a larger trend since the financial crisis that involved hedge funds changing the way they ran their firms.

Before the crisis, many hedge funds left clients in the dark about their strategies and their overall approach to investing. In those days, client simply shelled out a couple million dollars, received performance updates and paid their enormous 2 percent and 20 percent fees.

Since the crisis though, more hedge funds have opened up their doors and taken a more consultative approach with clients. Much of that is the result of stricter rules from regulators, and due diligence requirements by deep-pocketed investors.

Giant institutional investors expect a lot more information these days than hedge funds were open to sharing just a few years ago. Hedge funds are no longer keen on keeping their doors (and books) closed to investors looking to allocate hundreds of millions of dollars.

Not surprisingly, institutional investors have since been the been the main driver of surge in hedge fund assets.

According to a report from Citigroup, institutional clients made up 20% of hedge fund assets in 2002, while family offices and high-net-worth individuals made up the rest. By 2007, institutional investors made up 47% of the industry’s total assets, and today they account for 65% of hedge fund assets.
Further, the report noted that that institutional investors will help boost total hedge fund assets to a whopping $5.8 tillion in 2018.
Steven Russolillo of the Wall Street Journal also reports, Hedge Fund Industry Surpasses $3 Trillion for First Time:
The hedge-fund industry exceeded the $3 trillion barrier in May for the first time ever, according to one research firm, as new allocations and performance gains pushed total assets to a new record.

Some $22 billion flowed into hedge funds last month, bringing the year-to-date inflows to $93 billion, according to data provider eVestment. That’s the largest five-month total to start a year since 2007. Performance gains also added $37.8 billion in assets last month, leaving the total tally just north of $3 trillion.

Cash has flowed into these hedge funds despite relatively muted performances over the past several years. Many hedge-fund managers have underperformed their benchmarks as the stock market has surged to record after record. Hedge funds suffered back-to-back monthly declines in March and April for the first time since April and May of 2012, according to researcher HFR Inc. These funds rebounded in May and posted gains across all main strategies, HFR said earlier this month.

And yet, capital continue to flow toward hedge managers who purport to be better positioned for a potential market downturn.

Much of the cash coming to hedge funds has been allocated to stocks. Some $11.5 billion were added to equity strategies last month, or a little more than half of the monthly inflow, eVestment says. That brings the year-to-date total to equity funds to $59.4 billion, the best start to a year since mid-2007, eVestment said.

EVestment is the first to put total assets in the hedge-fund industry at more than $3 trillion. Other research firms have stuck to more conservative estimates. Data firm HFR pegged the industry at $2.7 trillion in April, the same month that trade publication HedgeFund Intelligence measured it at $2.6 trillion.
And Clayton Browne of ValueWalk gives us some numbers as he reports, Hedge Fund AUM Tops $3 Trillion For First Time:
Hedge funds continue to grow in popularity among global investors. According to a new report from eVestment, strong inflows and returns pushed total hedge fund assets under management above $3 trillion for the first time ever in May 2014. the total of $3,001.77 trillion just edges past the prior all-time high set in the second quarter of 2008.

Hedge funds see strong inflows this month

Hedge funds once again saw strong allocations in May. According to eVestment’s Hedge Fund Asset Flows, May was the fourth consecutive month of to see high hedge fund inflows. The more than $22 billion of new funds takes year-to-date flows to above $93.3 billion, the biggest five month total to begin a year stretching back to 2007(click on image above).

Strong performance gains

The eVestment report also highlighted strong performance gains for hedge funds for the month. “Performance gains added $37.8 billion to total AUM for an estimated asset weighted return of 1.28% in May, well above the 1.00% the industry produced on an equal weighted basis during the month. For the first five months of 2014, equal and asset weighted returns are nearly identical, both just below 2.00%” (click on image above).
Alternative equity exposure continues to grow

Allocations to to equity exposure continued to increase in May, a trend now in place for 11 consecutive months. The new $11.5 billion inflow to equity strategies during the month brings YTD inflows to just above $59.4 billion, the most investor interest in equity hedge fund exposure over a five-month span since mid-2007.
Event-driven strategy funds saw positive inflows

The report also pointed out that allocations to event driven strategy hedge funds grew in May. The $6.4 billion of new money takes total event-driven allocations to $31.1 billion so far in 2014. Of note, activist strategies represent 70% of event driven fund inflows reported in the month, indicating the sector took in somewhat over $4 billion in May.
Managed futures strategies still lagging

Managed futures strategies remain a laggard. This sector has simply not yet seen the return of positive investor interest that most macro strategies have enjoyed. The managed futures strategies sector suffered their ninth consecutive month of outflows in May, and the twentieth month of net redemptions out of the last twenty-one.
So what should investors make from the numbers above? First, it's important to keep in mind that the 500 largest hedge funds control 90% of the assets under management. Bridgewater, the world's largest hedge fund, manages roughly 6% of this total (see my recent comment on the soul of a hedge fund machine).

The big boys are getting bigger for the simple reason that they are able to better address the stringent requirements of large institutional investors who are demanding a lot more from their hedge funds. But the big boys are also good at marketing themselves and spend big bucks coddling their institutional investors as well as useless investment consultants that have effectively become the gatekeepers and herd everyone into the same brand name funds.

Second, while hedge funds have underperformed the stock market since the crisis erupted in 2008, so has everyone else. Institutional investors don't care if hedge funds underperformed stocks. They are diversifying their bond portfolio looking to get extra yield without the volatility of stocks.

But notice how the bulk of the new assets flowing into hedge funds is going to L/S Equity. There is a ton of beta in these equity hedge funds, which makes you wonder why are institutional investors paying overpaid hedge fund gurus 2&20 when they're better off investing in stocks? (you can say the same thing on credit hedge funds, tons of beta betting on direction of interest rates).

The answer is that while stock averages remain close to all-time highs and this bull market keeps repeatedly defying predictions of its demise for five-plus years, people are worried that the worst is yet to come. Nobel Laureate, Robert Shiller, is worried as the cyclically adjusted price-to-earnings ratio (CAPE or the Shiller P/E) he created stands at 26, well above its long-term average of 17 and approaching levels that previously presaged doom for equities.

"It looks to me like a peak," he says in this video. "I would think there are people thinking 'it's gone way up since 2009, it's likely to turn down again.' That's what people might plausibly think."

But one thing I learned in my career is to always remember the wise words of Keynes, namely, "markets can stay irrational longer than you can stay solvent." And even though I am worried of debt-deflation down the road, I know there is plenty of liquidity to drive risk assets much, much higher. That's why I recently came out to urge pension funds to stop loading up on linkers and start loading up on risky stocks and position themselves for a summer or fall melt-up.

As far as the hedge fund love affair, I prefer liquid alternatives over illiquid alternatives but think investors are setting themselves up for disappointment. Like all love affairs, once the initial arousal dissipates and reality sets in, it isn't as sexy or glamorous. Tread carefully with hedge funds and make sure these large funds maintain alignment of interests (most are large asset gatherers).

Once more, please remember to contribute or subscribe to my blog on the top right-hand side. I thank those of you who support my efforts and value my work and ask others to support this blog.

Below, Credit Suisse Private Banking CIO Michael O’Sullivan discusses investor behavior, why they are all over the board and investing in hedge funds with Anna Edwards and Mark Barton on Bloomberg Television’s “Countdown.”

And Agecroft Partners Founder and Managing Partner Donald Steinbrugge and Bloomberg Contributing Editor Fabio Savoldelli discuss hedge fund performance. They speak on “Market Makers”and state investors are happy with hedge funds.

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