Investors pulled money from hedge funds in December capping a volatile Q4

Positive returns drove industry AUM higher in the quarter, despite negative investor flow. The industry finished 2012 with assets increasing 5.9 per cent from year end 2011.

Total estimated assets climbed 0.5 per cent in December to USD2.601trn, the highest level of the year, but they remain 13 per cent below the all time peak set in Q2 2008.

Investors withdrew an estimated USD9.5bn in December resulting in a negative net investor flow in Q4 of USD10.3bn. For the full year 2012, investors added an estimated USD29.2bn, only slightly higher than the USD26.5bn added in 2011.

On a core growth basis (growth due solely to investor flow), the industry has grown only 1.1 per cent and 1.2 per cent in 2011 and 2012, respectively, compared to its post crisis rebound in 2H 2009 of 5.1 per cent and 3.7 per cent in 2010. A primary reason for the decline has been the longer term trend shift of direct investment which has created a drag as assets are removed via funds of funds, while being reallocated directly over time.

December and Q4 flows encapsulated the year for hedge fund investor activity. Assets continued to be added to credit and macro funds, equity strategies faced large redemptions, and commodity funds lost assets.

Credit hedge fund AUM first surpassed equity strategies’ in October 2012. Since then, divergent flow trends and continued strong credit fund performance make it appear the advantage may not be short term.

The preference for credit and macro exposure indicates hedge fund investors are wary that forces driving equity market valuations may be less in tune with historical manager expertise. Investors appear to believe there is greater opportunity to extract positive returns across credit markets, or through those funds able to extract alpha from macro themes.

Global macro and managed futures investor flows historically tended to move in similar directions. In the last five months to close 2012, the trend has stopped. Macro fund flows were positive each month with USD8.2bn of inflows, while managed futures funds lost an estimated USD10.0bn. The divergence indicates investors are less interested in what are primarily quantitative exposures to futures markets, and prefer more discretion in the process or more diverse asset class exposure.

One interesting shift in trend towards the end of 2012 has been a decline in the persistent outflows from emerging market funds. Since large losses first appeared post- financial crisis in May 2010, monthly EM fund flows were consistently negative and an estimated USD29bn was removed through July 2012. Since July, flows have been positive in four of the five months, and despite net flow being negative over that time frame it is significant that the constant monthly outflows appear to have abated.