PA ANALYSIS unwelcome return of hedge funds

After six years of graft hedge funds’ AUM have overtaken their 2007 level but will it take another six years for wealth managers to be as accepting?

PA ANALYSIS unwelcome return of hedge funds

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This is largely down to institutional investors piling in as at the end of 2013, Portfolio Adviser reported through its analysis of the Trustee Managed Portfolio Indices that private client portfolios had halved their allocation to funds of hedge funds.

Multiple assets

Before 2008, hedge funds were labelled as high risk/high return investments before the strategies they used were converted into UCITS funds, labelled ‘absolute return’ and sold to a wider audience. During the most recent of the past six years, this retail and intermediary audience has been moving back towards using single strategy hedge funds and has also moved to the other extreme of using hedge funds as a low risk allocation.
 
Interestingly, it was the Trustee MPI low-risk portfolios that had greater exposure to alternative investments, holding 13.1% at the end of last year compared to 8.4% in the higher risk portfolios, in funds of hedge funds (3.2% in high risk portfolios, 3.7% in low risk), commodities, private equity and real estate.
 
For anyone rushing off to read the Trustee MPI, it defines funds of hedge funds as ‘other’, bracketing commodities, private equity and real estate together under the ‘alternatives’ title.

The good side of volatility

It would appear now that the outlook for hedge funds is rosier with one of the biggest private banks more positive across the piece on private equity, real estate and hedge funds.

As far as hedge funds are concerned, looking ahead into the second quarter of the year, Faraz Sultan, global head of portfolio management and advisory at HSBC Alternative Investments sees plenty of opportunities.

He cites positives in rising volatility that is here for the foreseeable, falling correlations, diverging emerging market performance, and an increase in M&A activity.
 
“In our view, the trends that began last year, such as more fundamentally driven equity markets and more dispersion between asset classes and within asset classes, should continue to provide abundant opportunities for hedge fund managers,” he says.
 
Within the hedge fund asset class he is a fan of equity long/short strategies, supporting another trend that has been seen for the past year or so, with stock-picking fund managers coming to the fore.

Single strategy

“Thanks to higher stock price dispersion, 2014 should continue to be a good environment for stock pickers, especially as earnings becomes a more important determinant of equity price moves than P/E multiple expansion. As a result, we believe that equity long/short managers – one of the larger hedge fund strategies – should continue to perform well,” adds Sultan.
 
More hedge fund analysis published recently is from Lyxor, part of the Société Générale Group, that commented on there being strong divergences between the different hedge fund strategies, +/- 15%, since 2008.
 
“Investors should now look at the relationship of hedge funds with traditional asset classes to better invest into them,” according to the report’s co-author Ben Zheng.

Equity and bond behave-alikes

The way Zheng looks at hedge funds is to group them by their exposure to common risk factors as well as their capacity to generate uncorrelated absolute returns – essentially he sees them as high alpha and high beta to then categorise them as equity or bond substitutes.
 
This equity/bond split is already in place with some wealth managers. City Asset Management is one such firm, as James Calder research director explains: “We do not consider structured products, long/short or market neutral strategies to be alternative but rather sub-sets of the equity or bond asset class they derive their value from.
 
Whatever happens in the institutional world, with a natural lag, often ends up in the intermediated world of UK wealth managers. Whether – or when – this will be reflected in private client portfolios we will see in a minimum of six months’ time but whether – or when – it does, the Trustee MPI [and therefore Portfolio Adviser!] will pick up it first.

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