Big funds get bigger as hedge fund market recovers
Investors are often accused of having short memories and, when it comes to hedge funds, many market commentators believe the accusation holds true. Little more than five years ago the hedge fund market was one characterised by dwindling returns, plummeting assets and hedge fund companies going out of business. In 2012, the number of hedge funds disappearing from the market rose for the third year in a row to 873, according to HFR, a data provider. During the same year, while the average hedge fund again lost money for investors, the collective pay of the 25 richest managers fell by more than a third to $14.4bn.
The days were dark post 2008. Fast forward to 2014, however, and the latest figures from the annual Towers Watson/Financial Times Global Alternatives survey paint a significantly rosier picture for the hedge fund industry. The survey, which covers seven asset classes and seven investor types, shows that total assets managed by the world’s top 100 alternative asset managers rose to $3.3tn last year from $2.9tn in 2012, on the back of a marked increase in money flowing into hedge funds. The largest slice of this $3.3tn, some 32 per cent, was allocated to real estate funds but hedge funds accounted for 28 per cent, with both pension funds and insurance companies increasing their exposure to the sector. Damien Loveday, global head of hedge fund research at Towers Watson, says: “The results show an ever-expanding market, which is phenomenal really given the grilling hedge funds got just a few years ago. At one time you literally couldn’t move for negative headlines, but the industry has changed a lot since 2008.” The recent spike in assets, however, comes amid concerns that hedge funds’ correlation with the equity market has risen back to pre-financial crisis highs, raising fears that the market could again suffer sharp losses in the event of a market slide. Data compiled by AQR, a $105bn hedge fund house, show the three-year rolling correlation of the HFRI Fund Weighted Composite index, a broad industry measure, with equity markets is at a near-record high of 0.93, comfortably above the highs seen before the financial crisis. Some large investors have taken flight, including Calpers, the $288bn California public employees fund, which was one of the first US public pension plans to invest in hedge funds. Its portfolio managers have begun cutting the fund’s $5.3bn hedge fund allocation in half. “I think this is a yellow flag being signalled now,” David Kabiller, founding principal of AQR, told FTfm. “A lot of hedge fund managers are putting a lot of beta in their portfolios because it is what has worked. “Investors are getting screwed because they have beta elsewhere and now they are paying 2 and 20 [2 per cent of assets and a 20 per cent performance fee] for it.” Mr Loveday recognises the problem. “Investors want double digit returns but in an environment of low volatility and low cash rates hedge fund managers are struggling to meet expectations. “As a result it is true that some hedge funds are taking directional bets on the market but are dressing up their funds as something else. I am definitely paranoid about that. Investors need to do their homework and drill down into what is really going on with some strategies.” Away from the fears about correlation, the Towers Watson/Financial Times survey shows that the big hedge fund managers continue to get bigger, with Bridgewater Associates, Brevan Howard, BlackRock, Och-Ziff and BlueCrest Capital Management managing the lion’s share of assets on behalf of pension funds. Figures from Preqin, a research house, confirm this. Its analysis finds the 500 largest hedge fund managers control 90 per cent of industry assets, with the 505 hedge fund managers that run at least $1bn responsible for $2.39tn of the industry’s $2.66tn total assets. “The $1bn club is one which many emerging hedge fund managers strive to be a member of,” says Amy Bensted, head of hedge fund products at Preqin, adding that public pension funds represent the largest chunk of capital invested by $1bn-plus hedge fund investors (25 per cent), followed by sovereign wealth funds (16 per cent, up from 7 per cent a year ago) and private sector pension funds (15 per cent). Ms Bensted suggests there are some key ingredients needed for a hedge fund to grow to this $1bn-plus level. “The largest managers have typically shown consistent performance through many market cycles and demonstrated that they can outperform competitors. They have also settled on two approaches – specialisation in a core strategy or diversification across several different strategies,” she says. According to Preqin, New York is home to the largest number of $1bn-plus managers (174) while London is second with 80. “With large investors, such as public pension funds, allocating approximately $650bn to hedge funds – an 18 per cent increase from this time last year – it will become ever more important for hedge fund managers to attract inflows from these prominent institutions,” says Ms Bensted. “Big managers are definitely getting bigger,” adds Mr Loveday. “But that poses its own problems. It’s much harder for a fund to be a creator of value when it’s $50bn in size compared to $5bn. And that’s something investors must be aware of.”