Hedge funds produce best returns in 4 years
Strong performance from managers who bet on stocks restores optimism
The global hedge fund industry last year produced its best returns since 2013, driven by strong performances from managers who bet on stocks.
Advisers say it is too early to be sure this return to form will assuage investors’ concerns about high fees and mediocre long-term profits. But a cautious optimism has returned to the industry after the outflows of 2016 — the worst year for flows since the financial crisis — and many managers posted robust, or even eye-poppingly good, returns.
“In 2017 hedge funds as a strategy finally justified their cost of capital,” said Scott Warner, a partner at the fund of hedge funds Paamco. “But to really start to drive money back into the asset class, we’re going to have to see a more sustained period of performance.”
Funds that can make both positive and negative bets on stock price movements, known as long-short equity funds, were some of the best performers of the year, helping to retain money that investors had been rapidly shifting towards cheaper, passive and more liquid products.
Some of the biggest long-short equity shops had funds that returned double-digits last year. Some smaller managers did particularly well: Whale Rock Capital and Light Street Capital returned 36.2 and 38.6 per cent, respectively, off the rise of technology stocks including Alibaba.
Tiger Global, one of the largest long-short managers, had returned 27.5 per cent as of the end of November.
“There was really good stock selection both on the long and short side,” said Jon Hansen, a director of hedge funds at Cambridge Associates, an investment consulting firm. “When managers were right in 2017, they tended to be rewarded for that on both sides of the book.”
Activist funds performed strongly, too. TCI, the London-based activist, was up 28.2 per cent for the year. Marshall Wace, Lansdowne, Cevian Capital, Teleios Capital, Brenner West and Naya Capital all had funds with returns in double digits for 2017 as a whole.
Figures tallied by HFR, the research group, this week show that hedge funds across all strategies produced returns of 8.5 per cent in 2017, better than the 5.4 per cent recorded in 2016. Equities hedge funds — which include long-short funds, growth and value funds and sector-specific strategies — were up 13.2 per cent, their best showing in four years.
The revival in fortunes came just in time. Bob Leonard, a managing director at Credit Suisse’s investment bank and its global head of capital services, said equity long-short had been “on a lot of people’s watch lists” for possible redemptions.
But, while investors who are currently invested in equity long-short funds that outperformed are likely to stay, they are still unlikely to add to the allocation, he said. All equity funds were buoyed by rising stock valuations, as the S&P 500 rose 19 per cent last year.
“Some are thinking that equity valuations are getting a bit stretched, and no one knows when or how this ends, but some institutional investors are taking chips off the table,” Mr Leonard said.
“As long as investors continue to think or feel like we’re getting a bit pricey in the developed markets, strategies like global macro is top of mind,” he added, because these are funds that can shift money between whole markets. “If you’re going to add equity long-short, you as a manager need to really prove to us how this is going to be diversified and uncorrelated.”
Macro funds managed returns of just 2.3 per cent in 2017, according to HFR, but that was better than the 1.0 per cent of the previous year. Relative value funds, which trade mainly in the credit markets, returned 5.3 per cent, less than the 7.7 per cent in 2016.
Despite the industry’s overall higher returns of the past year, investors are still wary of hedge funds. The high fee structure — traditionally a 2 per cent fund management fee and a 20 per cent performance fee — came under fire.
Funds responded by reducing fees, and the money that still flowed into the sector was consolidated mostly at the largest funds. Hedge fund closures outpaced the number of funds that opened in 2017 for the third year in a row, claiming several veterans of the industry. John Griffin’s Blue Ridge Capital, Neil Chriss’s Hutchin Hill Capital and Eric Mindich’s Eton Park Capital all shuttered, while Paul Tudor Jones closed one of his funds.
Don Steinbrugge, chief executive of investment consultant Agecroft Partners, predicted that while the amount of money managed by the industry would continue to grow in 2018, the number of hedge funds closing down would also rise.
“The hedge fund industry remains oversaturated,” he said in a note to clients. “We believe approximately 90 per cent of all hedge funds do not justify their fees . . . Some large managers are simply too large to maintain an edge.”
After investors pulled $70bn from hedge funds in 2016, $2.9bn in fresh capital trickled in over the first nine months of 2017. A final figure for the year will be out later. Mr Warner said managers at Paamco are “not seeing huge investor demand to pile back in, but an abatement of the pressure to redeem has occurred.”
Added Mr Hansen: “We went through a stretch where there was a lot of negative sentiment about hedge funds. That seems to have abated.”