Exploring growing opportunities in hedge funds amid global uncertainties

Continued turmoil in Europe has created market dislocations and increased global market volatility. Reduced lending activity from financial firms - combined with the continued divesting of assets - has contributed to an asset supply/demand imbalance. Additional regulatory changes, such as the BASEL III implementation, will likely increase market distress. We believe this environment is particularly attractive for hedge fund managers who can identify individual equity/credit positions that have been oversold and who can monetize the volatility resulting from these market forces.

 

Some of the key themes and trends in the hedge fund investment space, global and in Asia, are as follows:

 

1) The search for institutional quality continues

 

Institutional investors have rushed into hedge funds as part of the larger trend to seek alpha and pare down beta exposures. North American pension plans have increased their hedge fund allocations by USD250 billion since 2009, more than any other type of investor, according to recent Barclays Capital research. Further, a survey of BlackRock’s institutional investors revealed that 23 percent expected to increase portfolio exposure to alternatives in the next 12 to 24 months. 

 

High dispersion between hedge funds makes manager selection a difficult task. Funds that simply repackage beta sources and charge hedge fund fees are not suitable for institutional investors. Investors should have a clear understanding of the systemic exposures present in the strategy and strong confidence that the hedge fund can produce real alpha. Only firms that can pass such stringent due diligence should meet the institutional quality required by sophisticated investors.

 

2) Size/scale does matter... 

 

Assets managed by hedge funds have soared in recent years, staging a rebound from post-credit crisis lows and surpassing previous highs to cross the USD2 trillion mark for the first time. Recent trends show that capital has flowed to the largest players in the market; of the USD125 billion in net new flows 2010 - 2011, 70% percent went to hedge fund managers with over USD5 billion in assets.

 

However, a different trend has emerged for hedge fund of funds. Eighty percent of managers experienced outflows in 2011, and their proportion of total hedge fund assets has shrunk from 43 percent at peak in 2008 to 31 percent today. Still, select managers experienced steady growth. A strong trend of concentration and consolidation is evident; the largest managers now account for 36 percent of the market, up from 29 percent in 2005. These trends echo the advantages that scale can provide for an asset manager: increased access to information, insights and deal flow, as well as robust, multi-faceted risk management processes.

 

We now live in a world of big problems, but for the right investors they can also present tremendous opportunities. Investors must take care to identify top firms that have the breadth, scope, professionalism and resources to identify and take advantages of dislocations in and uncertainties in the markets today.

 

 

Joseph Pacini is the head of BlackRock Alternative Investment Strategy Group, Asia