Volatility and uncertainty will continue to pressure L/S equity, Hedge Fund Research warns

Date: Monday, January 23, 2012
Author: Charles Gubert, COO Connect

Market volatility and uncertainty will continue to put pressure on equity long/short hedge funds going into 2012, warned Kenneth Heinz (pictured), president of the Chicago-based Hedge Fund Research (HFR).

“It is difficult to say whether I am optimistic about long short/equity because the answer changes every 20 minutes with what is happening in the eurozone. The changes have been very dynamic. Earlier last week, Standard & Poor’s downgraded France and Austria from AAA to AA+ but simultaneously Italian and Spanish bond auctions went pretty well so it is hard to tell what will happen,” said Heinz.

Equity hedge funds suffered $8.6 billion in net outflows in the last quarter of 2011 reducing full year inflows to $2.2 billion. The HFRI Equity Hedge Index finished 2011 down 8.25%. According to HFR, 60% of all hedge funds experienced outflows during the fourth quarter.

“Equity long/short did not perform well in 2011 for several reasons. The biggest factor was the eurozone crisis where concerns over sovereign debt have been a key driver for asset prices. Another issue was many managers were overweight in energy and financials, which did not do well either. Many of the US banks did not perform as well as many had expected,” added Heinz.

Emerging market hedge funds concluded a disappointing 2011 with the HFRI Emerging Markets Asia ex-Japan Index slumping 17.21% while Russian and Eastern European-focused hedge funds declined by 18.16% . Fears of inflation and slowing growth in China and India, struggling Eastern European economies, the Tsunami in Japan and ongoing civil unrest in the Middle East have panicked investors. “Investors are certainly going to be less optimistic about emerging markets in 2012 than they were in 2011,” said Heinz.

Meanwhile, macro and relative value arbitrage proved to be the most popular investment strategies among allocators. Macro saw $27.9 billion inflows in 2011 while relative value, which was the only major strategy to post a performance gain in 2011 – a rather modest 0.51% - saw inflows of $35.9 billion.

HFR data showed investors allocated $50.7 billion of net new capital to firms with greater than $5 billion in assets under management (AuM), while firms with less than $5 billion experienced a combined net inflow of $20 billion.

Funds of hedge funds’ (FoHFs) woes continued as investors withdrew $7.2 billion in the fourth quarter bringing their total capital to $629 billion. FoHFs are still struggling to reinvent themselves in the wake of the financial crisis. During 2008, many performed abysmally and there were several, high-profile exposures to Bernard Madoff.

Research by Preqin in 2011 discovered only 24% of investors would allocate to a FoHF compared with 42.5% in 2010. Some hedge funds are increasingly offering investors customised portfolios and a growing number of allocators shirk at the additional layer of fees associated with FoHFs. Heinz said greater transparency among single managers had resulted in investors allocating directly to hedge funds rather than via a FoHF.

Total assets invested in hedge funds returned to the $2 trillion milestone in 2011 although it is not at its mid-2011 $2.04 trillion peak. Despite the HFRI Fund Weighted Composite Index dropping 5% in 2011, Heinz reckoned hedge fund global AuM could yet top its $2.04 trillion record.