Investors piling into tail risk hedge funds, according to JP Morgan

Date: Wednesday, October 5, 2011
Author: Charles Gubert, COO Connect

Investors are increasingly allocating to tail risk hedge funds as concerns continue to mount over the eurozone’s health and the US recovery.

Tail risk hedge funds give investors protection against black swan, extreme market events. Such funds, which include Arrowgrass, Bennelong and 36 South, have witnessed increases in assets over the last two months, according to a recent JP Morgan survey. Year-to-Date (YTD) returns of these hedge funds have also been positive with 36 South posting YTD returns of 93%, for example.

“Investors are putting these products into their portfolios to mitigate risk. Many investors still have memories of Lehman Brothers and are concerned about what may happen in the eurozone. Eurozone economies and the US are vulnerable right now,” said Nikolaos Panigritzglou, European head of global asset allocation and alternative investments at JP Morgan.

There are widespread fears that Athens could default sending shockwaves through banks with major Greek exposures. Meanwhile, the US is still ruing from its credit downgrade by Standard & Poor’s and is suffering from continued political bickering. “There is a fear of contagion, particularly among private bondholders who could get hit by Greece. In the US, the credit downgrade was a body blow and the political impasse is creating fear,” warned Panigritzglou.

Some market commentators have speculated that one, some or all of the PIGS (Portugal, Ireland, Greece, Spain) could leave the eurozone. Other naysayers have even predicted the demise of the eurozone. “The eurozone crisis has the potential to be worse than the Lehman aftermath if the private sector is unable to bail out Greece voluntarily. If this does not happen, we could be bracing ourselves for some major volatility in the markets,” highlighted Fabian Garavito, a member of JP Morgan’s global asset allocation and alternative investments research team.

While investors are piling into tail-risk hedge funds to mitigate macroeconomic risks, challenges do remain for these managers, the JP Morgan report stated. “Going forward, the challenge for these funds will be to find cheaper sources of tail-event hedges such as structured products, conditional hedges and use of longer-dated derivatives,” it said.

Hedge funds more broadly have underperformed this year with the HFRI Fund Weighted Composite Index down 1.22% YTD. Nevertheless, investors are sticking with alternatives and global assets under management have not only surpassed their $1.9 trillion peak of 2007 but topped the $2 trillion mark, according to data from the Chicago-based Hedge Fund Research.