Editor’s Letter – Issue 119

January 2017

Originally published in the January 2017 issue

Average hedge fund performance for 2016 was in line with the majority of institutional investors’ expectations, per Preqin; few now expect double-digit returns. EurekaHedge reckon the industry made 4.48%, the SS&C Globe Op Performance Index was up 5.11% and the HFRI Fund Weighted Composite Index advanced 5.6%. These returns are consistent with industry history, when defined as a spread over risk-free rates: still near zero in most OECD countries. Still, some event-driven, distressed debt, emerging markets and energy related strategies were well into double digits for 2016.

Yet the worst-performing strategy of 2016, managed futures (on average, with some notable outliers particularly among short-term traders) received the largest inflows, according to eVestment. This illustrates how many allocators are motivated by portfolio diversification rather than rear view mirrors. The search for uncorrelated returns remains the single most important reason for hedge fund allocations, as the 2016 EY Global Hedge Fund and Investor Survey (EYHFS) found.

Hedge fund industry assets remain at record levels of $3 trillion and the EYHFS finds that most institutional allocators intend to maintain stable allocations. After six consecutive years of asset growth, the industry paused for breath but we expect that the growth will resume. Liquid alternatives launches of high-calibre UCITS and ’40 Act funds continue, and are reaching out to wider audiences of investors. Meanwhile some vast asset management markets, such as the world’s fourth largest – Australia’s – are becoming easier to access.

Additionally, hedge funds are swiftly adapting to institutional investor demands. Customised fees and terms are now offered by more than half of the largest hedge funds, the EYHFS finds, matching the results of surveys from AIMA and Preqin. EYHFS also notes that more managers are offering customised liquidity terms and portfolio exposures, sometimes via managed accounts, ‘funds of one’ and co-investments.

Technology is another area where managers can differentiate with bespoke – rather than off-the-shelf – offerings. Hedge funds are applying next generation technology to investment. For instance, as one example of applying big data to investing, satellites are now being used to monitor ships and car parks. Advances in analytical techniques are providing insights into market regimes, earnings drivers, news, investor sentiment and market microstructure. The EYHFS highlights how artificial intelligence is now being employed by fundamental managers as well as quantitative ones.

Beyond the front office, technology is touching many facets of hedge fund businesses in middle and back offices, the AIMA/MFA/KPMG survey identifies. Transparency, data management and reporting are facilitated; trade processing, recording, reconciliation and controls are automated (possibly with BlockChain) and risk management is systematised, all using technology. But cybersecurity remains the largest technology worry, with over half of managers not confident that service providers and government agencies can safeguard their data, amid US government cyber breaches. As a maturing industry has devoted immense resources to meeting regulators’ demands, it is high time for reciprocity. Many managers’ New Year’s resolution will be to settle these cyber stresses and risks that have persisted for too long.