Hedge Funds Experience Net Inflows of Capital in 2006

Date: Monday, March 5, 2007
Author: RiskCenter Staff

Hennessee Group LLC, an adviser to hedge fund investors, estimates that hedge fund industry assets increased by $215 billion in 2006 to $1.442 trillion.  The increase in assets represents +17.5% growth over industry assets since the beginning of 2006.  Preliminary results indicate that the hedge fund industry experienced net inflows of $75 billion (+6.1%) in 2006.  The remaining $140 billion (+11.4%) was the result of positive performance, as evidenced by the Hennessee Hedge Fund Index, which advanced +11.4% in 2006. 

The hedge fund industry continues to grow as investors diversify their portfolios. The growth rate of net inflows at +6% is a modest increase from +4% in 2005, but is still significantly less than the +19% increase in 2004 and its peak of +34% in 2001.  

ASSET FLOWS

The majority of assets flowed to multi-strategy arbitrage funds as total assets for arbitrage and event driven funds were up approximately +31.5% in 2006.   The Hennessee Arbitrage/Event Driven Index advanced +12.3% for the year, as most arbitrage strategies posted double-digit returns.  Despite the well-publicized demise of Amaranth Advisors, positive fundamentals for arbitrage strategies, including tightening credit spreads and robust merger and acquisition activity, helped attract a significant amount of new capital for multiple arbitrage funds.  Asset growth in arbitrage and event driven funds is expected to continue as pension funds and institutions further increase their allocations to hedge funds. 

Long/short equity assets increased approximately +10.5% in 2006, with the increase coming entirely from performance, as the Hennessee Long/Short Equity Index advanced +11.1% in 2006.  New inflows to long/short equity funds were offset by investor withdrawals, fund liquidations, and the return of capital to investors. Furthermore, many large established long/short equity funds are no longer accepting new capital, and in several cases, even returning capital to investors in order to remain at a manageable asset size.  Hennessee estimates that over 30% of hedge funds managing in excess of $1 billion are currently closed to new capital.

INVESTOR SOURCES OF CAPITAL

Direct investments by individuals and family offices remain the largest source of capital for the hedge fund industry.  Going into 2007, Hennessee Group estimates they represent approximately 40% of total industry capital followed by fund of funds (23%), corporations (18%), pension plans (11%), and endowments and foundations (8%).