Man Investments: US economy could present opportunities for hedge funds

Date: Wednesday, December 5, 2007

Man Investments says that uncertainty over the US economy was likely to create substantial trading opportunities for hedge funds in 2008 but possible market disruptions could affect some strategies.

In its annual review and preview report on the hedge fund industry released this week, one of the world's largest suppliers of hedge fund products gave a mainly upbeat outlook for the industry in 2008

In the report, the firm's team of research economists predicts that hedge fund strategies likely to prosper next year will include relative value, event driven and managed futures.

Thomas Della Casa, Head of the Research, Strategy and Analysis Group at Man Investments and co-author of the report with analyst Mark Rechsteiner, says: 'The big challenge for hedge funds next year will be to adapt to the different possible macroeconomic scenarios that will materialize. Volatility will continue to be the key factor in determining how vigorously hedge funds perform.'

'Volatility arbitrageurs will, most likely, benefit from a general long exposure to various levels of volatility and frequently shifting sentiment. At the same time, fixed income managers will look for opportunities arising from uncertainty caused by central bank actions.'

For the event-driven hedge fund style, the authors expect continued strength despite the recent slowdown in the number of mergers and acquisitions. They say many companies with large amounts of cash on their balance sheets will be looking to external growth. In addition, managed futures strategies will benefit from difficult market conditions since these have, historically, created strong market trends which directional programmes can exploit.

The report observes that hedge funds started 2007 well and were able largely to navigate around the spring turbulence. In the period leading to the subprime crisis, most hedge funds had already built up a performance cushion and many managers expressed cautious views on the markets. Quantitative equity strategies, however, suffered losses during the summer turmoil due to unusual market behaviour which their models could not replicate.

Summarizing the summer events, Della Casa says: 'August was difficult for all hedge fund styles, with average downturns of at least 2% but, in many cases, much higher.

'However, the following two months turned out to be very strong for diversified funds of hedge funds, yielding returns of about 5 to 6% that more than compensated for the August falls. Even though, on early figures, November appears to have taken back some of these gains, given an average December the hedge fund industry is set to post its strongest year since 2003 with most funds exceeding performance targets.'

Assuming a future slowdown of the global economy caused by effects from the US housing market, rising energy costs and stricter credit availability, the report says: 'While market tailwinds are expected to abate, the alpha generating skills of hedge fund managers will be essential to meet investor expectations. In such an environment we would expect heightened volatility with clear sector and market differentiation.

'Those managers who will be unable to achieve set target returns and who lack the necessary risk management processes will find it hard to survive. This will further intensify the consolidation process in the industry.'