Hedge funds storm back into form

Date: Friday, March 22, 2013
Author: Sam Jones, Financial Times

With crisis in Cyprus, gloom in the UK's Budget and growing fears of a correction in the US Treasury market, you could be forgiven for thinking markets were as turbulent as ever.

For some, though, the sun is shining: 2013 has seen some of the strongest returns from hedge fund managers in years.

So much so that many managers are quietly speaking of a return to form for the $2tn global industry -- which has hardly covered itself in glory since 2008.

On average, hedge funds -- once known for their high-octane, high-earning trades and outsize manager pay cheques -- have underpeformed most major markets for four years running.

Indeed, excluding 2009, when assets everywhere rallied, the past three years have been dismal. The average fund made just 11 per cent during the entire period, according to Hedge Fund Research.

Compare that with performance for the first two months of this year: up 2.7 per cent for the average fund and just under 4 per cent for the average equity-focused fund manager, HFR data show.

Most top-tier funds have performed far better.

"If you look at CNBC, then everything is in crisis; but if you look at price action, most of the problems this year have been ignored in the markets," says Luke Ellis, president of Man Group, the world's second-largest hedge fund manager. "It feels relatively easy to pick stocks now after a period where trying to make a return out of anything was very hard."

Not that anyone is quite prepared yet to declare the hedge fund industry's fortunes reversed. Rallies -- and subsequent disappointments -- have been a hallmark of the past few years.

"There was definitely a moment in the first quarter of last year where it felt like things were picking up," says Mr Ellis. "And then look what happened. There was definitely a moment like that in the first quarter of 2011 too."

In 2012 the average hedge fund made just over 6 per cent, while in 2011 the average fund lost just over 5 per cent, according to HFR. The S&P 500 rose nearly 13 per cent during the same 24 months.

The proof, says Mr Ellis, "usually seems to come in the second quarter". This year, though, managers are more confident of their chances, even if it is only March.

Indeed, what aggregated performance numbers obscure are some of the more structural reasons why many are more bullish about the markets they are navigating, and the opportunities these provide.

In particular, of course, it is managers' belief that the eurozone crisis -- notwithstanding recent events in Cyprus -- has been brought under control that has boosted industry gusto.

Politicians' and central bankers' apparent commitment to solving the problems in the financial system -- or at least indefinitely propping it up -- have begun to be felt as a "solid floor under markets for the first time", says one leading equity fund manager. And that leaves non-macro managers to concentrate on the details they prefer.

"This year is going to be one of a return to more normal markets where fundamentals play a much more important role," says Melissa Carnathan, EMEA head of capital introductions at JPMorgan. "Fundamentals are going to start having a much bigger impact."

In terms painted with the broadest brush: companies, and not countries, are where opportunities may now lie.

Equity long/short managers -- which focus on going long and short stocks -- have stood out from the crowd in recent months, with many of the sector's biggest names posting large returns.

Lansdowne Partners, Europe's largest equity long/short manager, has seen its flagship fund rise 7.75 per cent in the year to March 8, according to an investor.

Odey Asset Management, another UK-based equity long/short equity fund, has performed well too. Its flagship fund is up 11.5 per cent so far this year.

Some are faring even better. Sloane Robinson's global fund is up 17 per cent for the year to March 8.

In the US, too, equity-focused managers are faring well. Glenview Capital's flagship fund was up just under 11 per cent in the first two months of the year. Leon Cooperman's Omega Advisors has had a strong start too, and was up 6.5 per cent at the end of February, according to an investor.

Two measures point to further good returns for such managers: correlation and dispersion.

With correlation between stocks lower and dispersion higher, managers are better able to use their skill to identify idiosyncratic opportunities.

Investors in hedge funds are following the returns too.

"Many investors had rotated out of equity long/short funds into macro and credit, but last year had a very bullish equity market and investors noticed that," says Ms Carnathan. "Now they are trying to rectify their underexposure. We are seeing a lot of inquiries. We have had more inquiries than in a long time."

Not that those investors - many of them now pension funds and other large, conservative institutions - expect a great amount. "A number of years of muted performance have led people to finally adjust their expectations," says Ms Carnathan. Where hedge funds once promised returns of 20 per cent or more, now 8 per cent will do.