Hedge fund rebound predicted

Date: Monday, June 15, 2009
Author: Steve Johnson, FT.com

The beleaguered hedge fund industry is poised for a reversal in fortunes as investors are lured back in by sharply improved performance.

Stinging investment losses and a wave of redemptions saw the industry’s assets contract to $1,330bn (£808bn, €948bn) at the end of March, according to Hedge Fund Research, from a peak of $1,900bn last summer.

However, the tide now appears to be about to turn, aided by average returns of 5.2 per cent in May, the best monthly performance since February 2000, says HFR.

Credit Suisse, which has surveyed 600 investors managing $7,000bn of assets, almost $1,000bn of that in hedge funds, predicted there could be a “significant bounce in inflows once investors regain their confidence, which is currently gaining momentum”.

Funds of funds, pension schemes, insurance companies, endowments and private banks typically held 17.8 per cent of their hedge fund portfolios in cash as of January, the Swiss bank found, compared with just 7.5 per cent a year earlier.

Assuming investors return to normal cash levels when sentiment turns, this implies $130bn will flood back into hedge funds, “even without counting the pending inflows from new investors and new allocations”, Credit Suisse said.

“Things have definitely stabilised. There is positive momentum and a lot of our hedge fund clients are seeing net inflows, although that is not across the board,” said Megan Kenney, a managing director in Credit Suisse’s capital services team. “The industry is in a much better place than a few months ago.”

The volume of hedge fund start-ups has also risen “dramatically” in the past three months, after “falling off a cliff last year” the bank said.

Separately, Huw van Steenis, chief European financials analyst at Morgan Stanley, revised up his forecast for the size of the hedge fund industry at the end of 2009 to $1,200bn-$1,300bn amid signs of a “material slowing” of redemptions.

Morgan Stanley estimated redemption levels ran at 20-25 per cent in the fourth quarter of 2008, 10 per cent in the first quarter of 2009 and just 5 per cent in the second quarter.

In another sign of improving confidence, London-listed hedge funds are now trading at an average discount of 18.5 per cent to net asset value, compared with a peak of 30.4 per cent in December, according to Royal Bank of Scotland.

Mr van Steenis suggested better performing equity long/short and global macro strategies funds were already seeing net inflows, benefiting managers such as Och Ziff and Man Group.

Ms Kenney agreed returning investors were thus far favouring the most transparent and liquid strategies.

On average, respondents to the Credit Suisse survey said 9 per cent of their hedge fund investments had been subject to “gating” – meaning quarterly redemptions were limited – and 7.1 per cent had been suspended.

As a result many cash-strapped investors had been forced to exit their more liquid holdings instead, meaning they are now underweight these strategies. Ms Kenney added that investors also felt more “comfortable” being in liquid strategies amid lingering fears of a “W” shaped economic recovery.

The post-crisis hedge fund industry is likely to look different from the pre-crisis version, Credit Suisse found, with much greater interest in managed accounts and a ten-fold rise in enthusiasm for hedge fund replication products, admittedly from a low base.