Hedge funds grow assets, but industry still underperforms

The hedge fund industry experienced a challenging year in 2012 with lower than average returns, fewer new fund launches, a larger number of funds closing down and a generally challenging capital raising environment. 

The hedge fund industry grew its assets by US$75 billion in 2012, according to statistics from Eurekahedge, but the data provider’s own Hedge Fund Index underperformed global equity indices. 

The Eurekahedge Hedge Fund Index gained 5.63 per cent during 2012 compared to the MSCI World Index, which rose 13.75 per cent, and the Standard & Poor’s 500 Index, which was up 16 per cent for the year.  

Hedge Fund Research, another fund tracking firm, saw a 5.5 per cent return for the average hedge fund in 2012, following losses of 5 per cent in 2011.  

Hedge funds started strongly during the first two months of last year before posting negative returns for four consecutive months as they struggled in volatile markets driven by political and macroeconomic factors rather than fundamentals. The performance picked up in the second half of the year, but the 2012 hedge fund returns were the lowest for a positive year, Eurekahedge said. 

Hedge funds focused on emerging markets offered the highest returns, as Asian funds, excluding Japan, were up 10.5 per cent and Latin American funds returned 11.2 per cent. Despite these returns, Asian funds experienced an outflow of capital, most likely in response to poor performance and losses of 12.4 per cent in 2011.  

The attraction of new capital remained challenging. Overall net capital inflows totalled US$19 billion, less than half the net capital that entered the industry in 2011, Eurekahedge noted. Positive asset flows into North American hedge funds of US$24.3 billion were contrasted by net outflows in Europe, Japan, Asia and Latin America.  

As a result, performance was the main driver for the industry’s asset growth. Total assets in hedge funds grew by US$75 billion, bringing the size of the industry overall to US$1.78 trillion.  

The formation of funds slowed in 2012 with 959 new hedge funds, while the number of fund closures was the highest since the financial crisis with 860 funds closing down.  


Winners and losers 

In terms of strategies, distressed debt funds delivered the strongest performance, gaining 12.2 per cent in 2012. Hedge funds investing in mortgage bonds and subprime mortgages fared especially well and were significant winners last year. Metacapital Mortgage Opportunities Fund, which invests heavily in formerly Fannie Mae and Freddie Mac mortgages, returned 37.8 per cent in the first 10 months of 2012, making it the top performer of hedge funds managing $1 billion or more in the Bloomberg Markets list. 

Fixed income and relative value hedge funds also finished the year with double digit growth.  

Computer-driven trend-following funds, so-called quant funds, lost 3.4 per cent last year after a 7.9 per cent decline in 2011, according to the Newedge CTA Trend Sub-Index. Quant funds experienced strong performance in 2008 and had previously seen strong capital inflows.  

Macro strategies also had another dismal year with an index tracking macro funds losing 0.5 per cent last year, HFR said. At the Cayman Alternative Investment Summit in November, panellists discussed the poor performance of macro funds.  

Larry Powell, deputy chief investment officer for Utah Retirement Systems, said in today’s environment macro managers are employing different capped-risk, options-based strategies.  

With so many things happening in the global markets at the same time, macro managers are facing difficulties even though the equity markets have recovered, he said, arguing that macro managers, who are essentially trend followers, struggle when there are no consistent trends.  

In a year that switched between “risk on” and “risk off” modes with violent swings in the equity markets, hedge funds’ short positions taken in response to the euro crisis and other risk factors suffered.  

In addition to the lack of clear trends in the global economy, which is driven by political debates over the “fiscal cliff” in the United States and the sovereign debt and economic crisis in Europe, the changing investor base with a shift toward institutional investors was identified as one of the reasons for the poor performance of the average hedge fund.  

Former AIMA chairman Todd Groome said pension funds and endowments are less willing to accept volatility.  

“They talk about higher quality returns and when they define that, it is about lower volatility and 
greater loss protection,” he said.  

With a stronger focus on the preservation of capital, returns inexorably decline.  

Others blamed the increasing size and maturity of the industry with statistics showing that smaller, younger hedge funds typically perform better than larger, more established ones. 

“It seems that there is a tendency for managers to attempt to reduce risk for older and larger funds which hurts returns,” said Silvercreek Management’s Louise Morwick at the event in November.