![FINANCIAL TIMES MONDAY JANUARY 6 2014 9
“There’s something happening
here.What it is ain’t exactly clear.”
Buffalo Springfield, the 1960s
rock group that penned these
words, was certainly not writing
about hedge funds in 2013. But
they could have been.
Reports abound of money osten-
sibly gushing into the industry,
despite mediocre performance
since markets melted down five
years ago. The least likely strate-
gies are seeing strong asset
growth. And 100 companies now
control 61 per cent of all assets, or
$1.4tn, despite government policy
moves against “concentrated risk”
and entities becoming “too big to
fail”.
BarclayHedge, the global indus-
try data tracker and our prime
data source for this study, found
that since industry assets fell by
nearly 30 per cent to end 2008 at
$1.66tn, investors have been
returning steadily. By the end of
the third quarter of 2013, the fig-
ure had reached $2.33tn, almost
matching the all-time asset high
set at the end of 2007.
Though surrounded by negative
sentiment, fixed income and
emerging market fund assets have
increased 13.44 per cent and 19.61
per cent, respectively, during the
first three quarters of the year,
reaching $318bn and $253bn.
Long-bias fund assets rose
nearly 17 per cent to more than
$175bn, suggesting investors think
fairly naked equity exposure is
OK, despite an ageing bull mar-
ket. Assets in more traditional,
hedged long/short equity funds
have barely budged, and are now
at $174bn.
Meanwhile, the industry is fin-
ishing its fifth consecutive year of
underperforming stocks, cumula-
tively trailing EAFE, an index of
non-North American developed-
world stocks, in dollar terms by
26.6 per cent and the S&P 500 by
more than 62 per cent over this
period.
We experienced firsthand how
difficult the search was for just
five proven managers (see page 10
and 11) with the following parame-
ters: fund assets of between $100m
and $750m; more than five years of
performance history; consistent
double-digit annualised returns;
moderate to low volatility; and
modest historical drawdowns.
Last year, Kent Clark, Goldman
Sachs Asset Management’s chief
investment officer of hedge fund
strategies, who oversees more
than $23bn, told us: “If you can
find any managers with good
long-term returns and moderate
volatility, let me know”. This still
rings true.
So why do investors seem
increasingly enamoured with
hedge funds?
“At the [global] epicentre of this
increased pace in asset growth is
the continued expansion in size
and number of the largest single-
manager firms in the US with
assets of at least $1bn,” reports
HedgeFund Intelligence, the
industry research company.
During the first half of 2013,
HedgeFund Intelligence found
this group grew in number by 18,
to 287 managers, whose total
assets increased by $110bn to
$1.57tn. That is more than two-
thirds of all hedge fund assets –
the highest concentration since
the pre-crisis peak. Now 11 US-
based firms are each managing
more than $20bn.
Asset massing by large manag-
ers reflects the growing institu-
tionalisation of the industry and
relative decline in wealthy indi-
vidual investors. Over the past
decade, Citi Prime Finance, the
global hedge fund advisory, found
institutional ownership of all
hedge fund assets has increased
from one-quarter to more than
two-thirds.
Institutions are pouring into
large funds, says Martin Käll-
ström, portfolio manager of hedge
funds at the $35bn First Swedish
National Pension Fund. They can
offer superior “investor comfort”
via effective transparency, dedi-
cated risk-management teams and
continuous vetting by advisers
and consultants.
“These funds can offer low-vola-
tility performance that is uncorre-
lated to the market, while claim-
ing to the have the capacity to
accommodate significant capital
inflows,” adds Mr Källström.
Preqin, the data provider,
thinks faith in these qualities is
the primary reason why “institu-
tional investors have stayed the
course with hedge funds, despite
performance concerns over the
past few years”.
Market underperformance is
also tolerated because the market
has twice melted down by half in
little more than a decade, says
Peter Rigg, who oversees $28bn
and is head of alternative invest-
ments at HSBC in London. Such
outsized volatility is contrary to
most institutional tolerance,
which seeks steady growth to
meet their investment mandates.
As an indirect result of the
financial crisis, Lisa Fridman,
head of European research for the
$8.8bn Paamco funds of funds,
sees many larger managers refo-
cusing on so-called risk-adjusted
performance rather than returns
alone, to help hold on to and
attract long-term institutional cli-
ents. These clients tend to have
lower sensitivity to the market.
This shift seems to be pushing
away rich individual investors
who are after more aggressive
returns, she says.
The performance impact of try-
ing to capture growing institu-
tional demand has varied by strat-
egy. Alexandre Col, group head of
multi-management at Banque
Privée Edmond de Rothschild,
says: “Event-driven/activist man-
agers are still content in taking
on risk in looking for outsized per-
formance with volatility.”
But he sees long/short equity
managers aiming lower and tar-
geting less risk to achieve more
stable, less volatile performance.
“And this is even more evident
with multi-strategy funds.”
With performance expectations
of large funds being ratcheted
down, fund performance is accord-
ingly being benchmarked not
against markets, but cash-plus tar-
gets. HSBC’s Mr Rigg says his
company’s benchmark is Libor
plus 6 percentage points. Mr Käll-
ström of First Swedish National
Pension Fund is focused on
achieving uncorrelated market
returns from his largely macro
exposure to smooth overall portfo-
lio performance.
Increasingly, leading institu-
tional investors seem to be satis-
fied with realising steady absolute
returns, even at the cost of signifi-
cant market underperformance.
This was made clear in a recent
global investment bank report
that confidently stated: “Despite
new market highs, funds refuse to
chase performance”.
In addition to swelling institu-
tional investor interest, there is
another explanation of the para-
dox of rising asset flows and lack-
lustre industry returns.
We asked BarclayHedge to sepa-
rate performance from asset
growth between January 2010 and
September 2013, focusing on the
period after the immediate effects
of the crisis were felt. We found
that of the $228bn of net new
money coming in to hedge funds
over this time, more than half
went into managed futures (that
is, commodity trading advisors).
Yet this sector represents less than
15 per cent of industry assets.
Furthermore, this strategy is set
to register its third consecutive
down year, significantly underper-
forming virtually all other broad
hedge fund strategies and the
stock market.
Net flow numbers may have
been greater had broad industry
returns been more vibrant. But
the industry response to 2008 has
altered portfolio construction sys-
temically.
Though one could argue hedge
funds did deliver impressive rela-
tive outperformance that year, the
substantial absolute hit taken by
investors fuelled demand for more
reined-in exposure and risk. This
further aligned hedge fund man-
agement with institutional
demands.
Certainly, response to the crisis
induced greater operational and
performance transparency. But it
also resulted in lower perform-
ance, as evidenced by five years of
market-trailing returns and grow-
ing correlation among strategies.
Our conclusion is that, with the
performance bar having been
reset lower and prospects of out-
sized gains more limited, inves-
tors should be more circumspect
about hedge fund exposure, given
the risks of investing in this field.
While institutional investors
claim large funds are helping
them meet their asset allocation
and performance models, we con-
tend exposure alone will not
improve portfolio volatility, espe-
cially taking costs and relatively
modest net returns into account.
We believe there are smaller
hedge funds out there, managing
less than $750m, that can add
unique and productive exposure
to portfolios, with managers who
know how to balance performance
and risk, not just act as hedges
against market uncertainty.
Industry research widely supports
this point.
Jonathan Kanterman is a fund
manager and industry consultant
Survey: weak
performance
fails to stop gush
of new money
Research
Eric Uhlfelder and
Jonathan Kanterman
take a look behind the
numbers to find five
exceptional funds
By relying only on BarclayHedge
for this survey – the oldest and
most comprehensive hedge fund
database – we ensure search
parameters are precise. All 13
data fields, including strategy,
assets, performance, standard
deviation, worst drawdown, Sharpe
ratio, firm assets and fees, are
treated consistently.
BarclayHedge started the
selection process by filtering 4,500
hedge funds, and then assembling
a list of more than 700 that run
between $100m and $750m and
have at least five years of verifiable
performance through June 2013.
We excluded sector and
commodity funds because of their
limited exposure and tendency to
produce outlying results.
This timeframe captures one of
the most challenging investment
environments and is the longest
tracked by a periodical hedge fund
survey.
We then screened for consistent
returns and low to moderate
volatility, with limited drawdown,
no change in portfolio manager[s]
during the study period, and
avoided funds that suspended or
gated. Those that made the first
cut then went through a
substantial due diligence review.
The difficulties we have
encountered this year in finding
compelling broadstrategy funds
forced us to expand our search
into niche and countryspecific
strategies, which we normally
avoid because of the inherent
limits it places on the manager.
Identified as statistical arbitrage,
RiverNorth primarily invests in
closedend funds. While its $82m
is slightly below our threshold, the
firm manages nearly $2bn in this
asset class.
AlphaGen Volantis targets small
cap companies in the UK. Perfin
Investimentos invests only in
Brazil. However, these equity
country funds demonstrate the
potential of what a good manager
can deliver, especially in a
struggling economy.
More detail on the methodology
and due diligence is available online
Methodology Separating the wheat from the chaff
Now 11 USbased firms
are each managing
more than $20bn
FTfm – Hedge fund analysis](https://image.slidesharecdn.com/weakperformancefailstostopgushofnewmoney-financialtimes-180106185520/85/Financial-Times-Weak-performance-fails-to-stop-gush-of-new-money-into-hedge-funds-1-320.jpg)
![FINANCIAL TIMES MONDAY JANUARY 6 2014 11
Perfin Investimentos Long Short
Manager: Ralph Rosenberg
Strategy: Equity market neutral/
cash plus
Perfin derived a simple way to deal
with Brazil’s fickle stock market to
deliver consistent double-digit
returns with low volatility and
drawdowns. It combines substan-
tial exposure to the country’s high
overnight interest rates, which
have averaged 10 per cent since the
fund started in 2007, with targeted
long and short equity positions,
whose net exposure ranges
between -10 per cent to 20 per cent.
The latter has enhanced annual
performance, ranging from 1 per
cent to more than 21.5 per cent.
The fund will sometimes under-
perform the Bovespa, explains
manager Ralph Rosenberg, as it
did in 2009 when the index was up
83 per cent. But when stocks
plummeted as they did in 2008
(down 41 per cent), the fund
gained more than 10 per cent. Bot-
tom line: Perfin’s cumulative
returns have outperformed Brazil-
ian shares 136 per cent vs -20 per
cent, while the average Brazilian
hedge fund has been flat.
Monthly report and performance
attribution documents reveal
cash’s significant contribution to
performance. The presentation doc-
ument focuses on the equity
investing strategy, which combines
core and opportunistic trading,
often involving the same stock.
Dufry South America, the
regional airport retail concession-
aire, was an early core holding. In
April 2010 the subsidiary was one
of many absorbed by its Swiss
parent. Consolidation has created
a global leader that is capturing
the benefits associated with the
steady rise in passenger travel.
Because the Swiss parent trades
in São Paulo, the fund has
retained its 2.5 per cent exposure.
Over the past five years, annu-
alised top-line growth has been
running at 10 per cent and under-
lying earnings growth at 13 per
cent. Since consolidation, this has
helped push shares up from R$150
($63) to R$402 in mid-December,
adding an average of 55bp a year
to the fund’s performance.
Cosan, another original core
holding that also represents 2.5
per cent of the fund, was Brazil’s
leading sugar cane and ethanol
producer. Between 2009 and 2012,
it decided to leverage its cash flow
to transform itself through acqui-
sitions into a transport and
energy infrastructure and renewa-
ble fuels leader.
Though now burdened with
R$9.8bn in debt, the market has
rewarded Cosan’s synergies by
pushing up the stock from R$25 to
R$40 over the past four years.
This has boosted fund returns by
2 per cent. Mr Rosenberg believes
subsequent deleveraging should
drive profitability and the stock.
Foreign institutional investors
would probably find the fund’s
equity exposure low for a long/
short fund. While the performance
fee is applied only to equity-related
returns, some investors may balk
at the management fee being
applied to the fund’s hefty cash
position. But the net results of this
hybrid strategy are compelling.
Quaesta Bond Global Select
Strategy: Global macro
Manager: Christian Graf von
Strachwitz
Perhaps the most critical thing one
can say about this Frankfurt-based
fund is that its name is a misno-
mer. Since it started up in 2005
under the management of Chris-
tian von Strachwitz, the fund has
been macro focused, investing in
equity indices, currencies and debt
to achieve steady returns of more
than 12 per cent a year. The fund’s
annualised standard deviation has
averaged 8.7 per cent over the past
five years, and its worst drawdown
was less than 11 per cent.
Equally compelling is this
$672m fund’s low correlation with
leading benchmarks. It has been
negatively correlated to the
JPMorgan EMU 1-10 year bond
index along with the Macro and
CTA fund indices. Its equity tilt is
captured in the fund’s modest cor-
relation to the S&P 500 (0.32) and
DJ Euro Stoxx 50 (0.43).
Such nonconforming numbers
come as no surprise once you
understand the manager’s mantra.
“Regardless of how attractive, we
avoid crowded trades,” explains
Mr von Strachwitz. His contrarian
posture is achieved through inde-
pendent research and analysis,
which he says helps him identify
where the market is heading.
For instance, when the US gov-
ernment periodically becomes
bogged down in debt-ceiling cri-
ses, Mr von Strachwitz has seen
German Bunds rally.
Quaesta saw an opportunity
when it sensed the supercharged
yen could not hold its high value
during the summer of 2012. Strong
European Central Bank support for
the euro combined with Japanese
monetary easing suggested upside
in a long euro-yen trade. After just
a couple of months, Quaesta closed
out this position, adding 1.6 per
cent to the fund.
Around the same time, Mr von
Strachwitz’s team believed Span-
ish and Italian sovereigns were
oversold on fears of collapsing
domestic economies and systemic
threat to the euro. Feeling the ECB
would be compelled to support
these markets, the fund started
buying Spanish and Italian bonds.
The trades received a boost when
the ECB reiterated its defence of
the euro and recommitted to its
sovereign bond-buying pro-
gramme. Steady bond appreciation
ensued, enhanced by an interest-
rate cut, which together added 4
per cent to the fund by mid-2013
when Mr von Strachwitz closed
out these positions.
Quaesta’s staff of 24 profession-
als maintains 15-25 investments
that last from several weeks to
several months. They protect the
fund’s downside through extensive
daily stress testing and application
of strict stop-losses to prevent indi-
vidual trades from dragging down
the fund by more than 1-3 per cent.
So far, it has worked well.
RiverNorth Capital Partners
Strategy: Statistical arbitrage
Managers: Patrick Galley and
Stephen O’Neill
Closed-end funds, the primary
security RiverNorth trades, have
been around for decades. There are
around 600 such exchange traded
funds, representing one out of five
securities listed on the New York
Stock Exchange, with no more
than about 10 firms trading around
the inefficiencies of this asset class.
This is an obscure strategy, but
Patrick Galley and Stephen
O’Neill are proving the merits of
trading in a less crowded space.
Since starting up in August
2007, the managers have racked
up annualised gains of more than
22.5 per cent a year through to
June 2013, with a trailing five-year
annualised standard deviation
that is under 10 and a worst draw-
down that is less than 8 per cent.
Closed-end funds offer unique
trading opportunities because their
market prices deviate significantly
from their net asset values. With
such funds built around specific
asset classes, their market prices
are moved by underlying valua-
tions and sentiment towards the
asset class.
Being able to go long and short,
the managers rely on statistical
arbitrage to identify discounts
and premiums in market prices
that they anticipate will change.
With more than three-quarters
of closed-end funds using leverage,
which averages 30 per cent to
boost yields of their dividend-pay-
ing holdings, yield-starved inves-
tors poured into these invest-
ments. This pushed the portion of
funds trading at a premium to 54
per cent as of September 2012. This
seemed rich to the managers.
By the spring, they saw their
opportunity when Ben Bernanke,
chairman of the US Federal
Reserve, hinted tapering of QE was
being considered. They assembled
a basket of municipal, high-yield,
emerging market and bank-loan
funds that represented up to 52 per
cent of RiverNorth’s gross short
exposure as of September 2012.
Between May and August of the
following year the managers
unwound this position. By the
autumn, 90 per cent of closed-end
funds were trading at discounts.
The trade boosted the fund’s per-
formance by 5 per cent.
During the fourth quarter of
2012, fears about the pending fis-
cal cliff hit covered call option
funds, capping a year of reduced
dividend payments as premium-
writing income fell, having cre-
ated a 15 per cent discount in
many such funds.
Seen as a temporary phenome-
non, Mr Galley and Mr O’Neill
established a 17 per cent long
position in a basket of these funds
by January 2013. The discount
quickly closed as budgetary fears
subsided. By September the man-
agers unwound the bulk of the
position, adding 3 per cent to
returns.
Without a down calendar year,
having gained more than 21 per
cent when markets collapsed in
2008, the managers have found a
niche that significantly topped
more familiar, crowded strategies.
RiverNorth’s Patrick Galley and
Stephen O’Neill are proving the
merits of trading in a less
crowded space
Several years of performance is
required to make a fair assessment
of our thesis that investors can
realise superior and operationally
less risky returns through refined
research and due diligence. But
here is what we have found so far.
With two years under our belts,
the five original funds we selected
in 2011 have almost doubled the
performance of the average hedge
fund, rising an average of 5.1 per
cent a year versus the
BarclayHedge Fund Index. They
have also outperformed the MSCI
EAFE Index, which was up 1.58 per
cent. But we underperformed the
S&P 500, which had gained an
average of 12.77 per cent.
Our topperforming funds were
the Harvest SmallCap [long/short
equity] Strategy (+10.65 per cent
per annum) and the Steelhead
Pathfinder convertible arbitrage
fund (+8.21 per cent). Our worst
and only cumulatively negative
performance from 2011 was the
Forum Global Opportunities
[macro] fund (2.99 per cent),
which was hurt by its high
conviction short position of
emergingmarket credits, which the
manager still thinks will play out.
Three of the five funds we
selected in 2012 have performed
very well, both relative to their
strategies and in absolute terms
over the past 12 months through
June 2013. GAM Talentum
Emerging Long/Short Equity fund
paced the way, rising more than 15
per cent, followed by the Parus
[long/short equity] fund, which
was up more than 12 per cent.
Talentum’s gains were founded
in the fund’s predominantly long
positions, spread across a variety
of countries and industries. And
potentially damaging currency
exposure was effectively hedged.
The performance of developed
marketfocused Parus was driven
by its bullish bottomup approach,
especially in financials, which
accounted for 70 per cent of
performance.
Two other funds we cited were
hurt by their defensive postures.
LJM Preservation and Growth, an
options strategy fund that had an
extremely consistent record
throughout its sixyear history, was
down 7.7 per cent, mainly due to
its performance in May 2013, when
it lost an extraordinary 9 per cent.
Omni Macro fund’s conviction
that quantitative easing was setting
up a bearish scenario for a richly
priced market proved costly as
stocks continued to rally,
generating a loss of nearly 6 per
cent over the trailing year.
More details on our performance
is available online
Record so far Tracking the performance of selected funds from previous years
FTfm – Hedge fund analysis
Selected funds
Source: BarclayHedge
Total return indices (rebased)
Jun 2011 2012 Jun2013
800
900
1000
1100
1200
1300
Barclay Hedge Fund Index
MSCI EAFE Gross Index (USD)
S&P 500 Total Return Index
FT Select 5 Hedge Funds (2011)
Christian von Strachwitz’s Quaesta
invests with a contrarian posture](https://image.slidesharecdn.com/weakperformancefailstostopgushofnewmoney-financialtimes-180106185520/85/Financial-Times-Weak-performance-fails-to-stop-gush-of-new-money-into-hedge-funds-3-320.jpg)
More Related Content
Similar to Financial Times - Weak performance fails to stop gush of new money into hedge funds (20)
Financial Times - Weak performance fails to stop gush of new money into hedge funds
- 1. FINANCIAL TIMES MONDAY JANUARY 6 2014 9 “There’s something happening here.What it is ain’t exactly clear.” Buffalo Springfield, the 1960s rock group that penned these words, was certainly not writing about hedge funds in 2013. But they could have been. Reports abound of money osten- sibly gushing into the industry, despite mediocre performance since markets melted down five years ago. The least likely strate- gies are seeing strong asset growth. And 100 companies now control 61 per cent of all assets, or $1.4tn, despite government policy moves against “concentrated risk” and entities becoming “too big to fail”. BarclayHedge, the global indus- try data tracker and our prime data source for this study, found that since industry assets fell by nearly 30 per cent to end 2008 at $1.66tn, investors have been returning steadily. By the end of the third quarter of 2013, the fig- ure had reached $2.33tn, almost matching the all-time asset high set at the end of 2007. Though surrounded by negative sentiment, fixed income and emerging market fund assets have increased 13.44 per cent and 19.61 per cent, respectively, during the first three quarters of the year, reaching $318bn and $253bn. Long-bias fund assets rose nearly 17 per cent to more than $175bn, suggesting investors think fairly naked equity exposure is OK, despite an ageing bull mar- ket. Assets in more traditional, hedged long/short equity funds have barely budged, and are now at $174bn. Meanwhile, the industry is fin- ishing its fifth consecutive year of underperforming stocks, cumula- tively trailing EAFE, an index of non-North American developed- world stocks, in dollar terms by 26.6 per cent and the S&P 500 by more than 62 per cent over this period. We experienced firsthand how difficult the search was for just five proven managers (see page 10 and 11) with the following parame- ters: fund assets of between $100m and $750m; more than five years of performance history; consistent double-digit annualised returns; moderate to low volatility; and modest historical drawdowns. Last year, Kent Clark, Goldman Sachs Asset Management’s chief investment officer of hedge fund strategies, who oversees more than $23bn, told us: “If you can find any managers with good long-term returns and moderate volatility, let me know”. This still rings true. So why do investors seem increasingly enamoured with hedge funds? “At the [global] epicentre of this increased pace in asset growth is the continued expansion in size and number of the largest single- manager firms in the US with assets of at least $1bn,” reports HedgeFund Intelligence, the industry research company. During the first half of 2013, HedgeFund Intelligence found this group grew in number by 18, to 287 managers, whose total assets increased by $110bn to $1.57tn. That is more than two- thirds of all hedge fund assets – the highest concentration since the pre-crisis peak. Now 11 US- based firms are each managing more than $20bn. Asset massing by large manag- ers reflects the growing institu- tionalisation of the industry and relative decline in wealthy indi- vidual investors. Over the past decade, Citi Prime Finance, the global hedge fund advisory, found institutional ownership of all hedge fund assets has increased from one-quarter to more than two-thirds. Institutions are pouring into large funds, says Martin Käll- ström, portfolio manager of hedge funds at the $35bn First Swedish National Pension Fund. They can offer superior “investor comfort” via effective transparency, dedi- cated risk-management teams and continuous vetting by advisers and consultants. “These funds can offer low-vola- tility performance that is uncorre- lated to the market, while claim- ing to the have the capacity to accommodate significant capital inflows,” adds Mr Källström. Preqin, the data provider, thinks faith in these qualities is the primary reason why “institu- tional investors have stayed the course with hedge funds, despite performance concerns over the past few years”. Market underperformance is also tolerated because the market has twice melted down by half in little more than a decade, says Peter Rigg, who oversees $28bn and is head of alternative invest- ments at HSBC in London. Such outsized volatility is contrary to most institutional tolerance, which seeks steady growth to meet their investment mandates. As an indirect result of the financial crisis, Lisa Fridman, head of European research for the $8.8bn Paamco funds of funds, sees many larger managers refo- cusing on so-called risk-adjusted performance rather than returns alone, to help hold on to and attract long-term institutional cli- ents. These clients tend to have lower sensitivity to the market. This shift seems to be pushing away rich individual investors who are after more aggressive returns, she says. The performance impact of try- ing to capture growing institu- tional demand has varied by strat- egy. Alexandre Col, group head of multi-management at Banque Privée Edmond de Rothschild, says: “Event-driven/activist man- agers are still content in taking on risk in looking for outsized per- formance with volatility.” But he sees long/short equity managers aiming lower and tar- geting less risk to achieve more stable, less volatile performance. “And this is even more evident with multi-strategy funds.” With performance expectations of large funds being ratcheted down, fund performance is accord- ingly being benchmarked not against markets, but cash-plus tar- gets. HSBC’s Mr Rigg says his company’s benchmark is Libor plus 6 percentage points. Mr Käll- ström of First Swedish National Pension Fund is focused on achieving uncorrelated market returns from his largely macro exposure to smooth overall portfo- lio performance. Increasingly, leading institu- tional investors seem to be satis- fied with realising steady absolute returns, even at the cost of signifi- cant market underperformance. This was made clear in a recent global investment bank report that confidently stated: “Despite new market highs, funds refuse to chase performance”. In addition to swelling institu- tional investor interest, there is another explanation of the para- dox of rising asset flows and lack- lustre industry returns. We asked BarclayHedge to sepa- rate performance from asset growth between January 2010 and September 2013, focusing on the period after the immediate effects of the crisis were felt. We found that of the $228bn of net new money coming in to hedge funds over this time, more than half went into managed futures (that is, commodity trading advisors). Yet this sector represents less than 15 per cent of industry assets. Furthermore, this strategy is set to register its third consecutive down year, significantly underper- forming virtually all other broad hedge fund strategies and the stock market. Net flow numbers may have been greater had broad industry returns been more vibrant. But the industry response to 2008 has altered portfolio construction sys- temically. Though one could argue hedge funds did deliver impressive rela- tive outperformance that year, the substantial absolute hit taken by investors fuelled demand for more reined-in exposure and risk. This further aligned hedge fund man- agement with institutional demands. Certainly, response to the crisis induced greater operational and performance transparency. But it also resulted in lower perform- ance, as evidenced by five years of market-trailing returns and grow- ing correlation among strategies. Our conclusion is that, with the performance bar having been reset lower and prospects of out- sized gains more limited, inves- tors should be more circumspect about hedge fund exposure, given the risks of investing in this field. While institutional investors claim large funds are helping them meet their asset allocation and performance models, we con- tend exposure alone will not improve portfolio volatility, espe- cially taking costs and relatively modest net returns into account. We believe there are smaller hedge funds out there, managing less than $750m, that can add unique and productive exposure to portfolios, with managers who know how to balance performance and risk, not just act as hedges against market uncertainty. Industry research widely supports this point. Jonathan Kanterman is a fund manager and industry consultant Survey: weak performance fails to stop gush of new money Research Eric Uhlfelder and Jonathan Kanterman take a look behind the numbers to find five exceptional funds By relying only on BarclayHedge for this survey – the oldest and most comprehensive hedge fund database – we ensure search parameters are precise. All 13 data fields, including strategy, assets, performance, standard deviation, worst drawdown, Sharpe ratio, firm assets and fees, are treated consistently. BarclayHedge started the selection process by filtering 4,500 hedge funds, and then assembling a list of more than 700 that run between $100m and $750m and have at least five years of verifiable performance through June 2013. We excluded sector and commodity funds because of their limited exposure and tendency to produce outlying results. This timeframe captures one of the most challenging investment environments and is the longest tracked by a periodical hedge fund survey. We then screened for consistent returns and low to moderate volatility, with limited drawdown, no change in portfolio manager[s] during the study period, and avoided funds that suspended or gated. Those that made the first cut then went through a substantial due diligence review. The difficulties we have encountered this year in finding compelling broadstrategy funds forced us to expand our search into niche and countryspecific strategies, which we normally avoid because of the inherent limits it places on the manager. Identified as statistical arbitrage, RiverNorth primarily invests in closedend funds. While its $82m is slightly below our threshold, the firm manages nearly $2bn in this asset class. AlphaGen Volantis targets small cap companies in the UK. Perfin Investimentos invests only in Brazil. However, these equity country funds demonstrate the potential of what a good manager can deliver, especially in a struggling economy. More detail on the methodology and due diligence is available online Methodology Separating the wheat from the chaff Now 11 USbased firms are each managing more than $20bn FTfm – Hedge fund analysis
- 2. 10 FINANCIAL TIMES MONDAY JANUARY 6 2014 FTfm select funds for 2013 survey through June 30 2013 Name of fund * There is no formal index for statistical arbitrage. It is a sub-category involving only 5 to 7 funds over the past 5 years. Accordingly, the related performance data is an average Fund assets ($m) AlphaGen Volantis Kawa Perfin Investimentos Long Short RiverNorth Capital Partners Quaesta Capital Bond Gl Select Barclay Hedge Fund Index S&P 500 Total Return Index MSCI EAFE Index (USD) 526.1 238.0 174.5 82.0 672.0 One- year return 16.65 10.68 11.58 9.74 11.34 5.36 9.86 1.58 11.17 4.56 10.09 20.60 15.15 Three-year annualised return 8.86 5.39 12.82 5.22 12.6 3.13 12.53 3.31 9.26 2.62 5.67 18.45 6.73 Five-year annualised return 11.14 3.30 18.21 5.29 15.16 0.80 22.12 8.42 15.83 2.08 3.26 7.01 -3.59 Annualised return since inception 15.00 10.10 16.89 9.82 15.45 5.59 22.57 9.09 12.12 8.40 9.43 11.40 7.85 Worst drawdown since inception 11.34 14.25 2.34 19.62 5.23 6.26 7.81 10.07 10.67 6.42 24.09 50.95 58.24 One-year standard deviation 5.56 2.57 1.79 3.55 2.32 1.52 2.67 4.46 7.13 3.43 3.31 6.45 9.17 Five-year annualised standard deviation 9.74 6.16 4.59 7.29 3.96 2.60 9.99 9.33 8.69 4.70 8.44 18.26 22.79 Sharpe ratio past five years 1.13 0.51 3.96 0.7 3.78 0.24 2.20 0.85 1.80 0.40 0.37 0.37 -0.17 Firm assets ($m) 103,000 498 1,313 2,130 3,125 Start date May 2002 Sep 2007 Oct 2007 Aug 2007 Mar 2005 Strategy Equity Long/Short Equity Long/Short Index Opportunistic Debt Event Driven Index Market Neutral / Cash Plus Market Neutral Index Staistical Arbitrage Statistical Arbitrage Average * Global Macro Global Macro Index Firm Henderson Global Investors Kawa Capital Perfin Investimentos RiverNorth Capital Quaesta Capital City London, UK Miami Beach, US São Paulo, Brazil Chicago, US Frankfurt, Germany Source: BarclayHedge, including all strategy averages AlphaGen Volantis Managers: Rob Giles and Adam McConkey Strategy: UK long/short equity smallcap Volantis has been so accom- plished that when its parent com- pany Gartmore agreed to be pur- chased in 2011, the buyer, Hender- son Global Advisors, agreed to sustain the fund’s operational independence. Its research and investments were ringfenced to help ensure Volantis’s continued outperformance. This $526m UK small-cap fund has performed like a global indus- try leader, generating annualised returns of 15 per cent since it started up in April 2002. Over that time, the comparable FTSE AIM (UK micro/small-cap) index was down an average of 0.7 per cent a year. Even more remarkably, manag- ers Rob Giles and Adam McCo- nkey’s performance has been achieved with low to moderate volatility, despite the backdrop of the British economy’s long drawn out recovery from recession. Agnostic about gross domestic product, the managers rely on their knowledge of under-analysed small caps. They are quick to iden- tify companies with technological and market-share advantage. After establishing a core position in a company, the managers often boost returns by also trading opportunis- tically in and out of the stock. Sepura is a global leader in Tetra digital radio products and networks used by police and emergency services. A change in management in 2008 caught the fund’s attention. At the end of 2009, with the managers having sensed the return of public spending, they started buying shares of Sepura at an average cost of 41p. Early the following year, Sepura secured one of the largest post-crisis roll- outs in Germany. Company prospects have been enhanced with the US approval of Sepura to sell in the country, and private industries expressing inter- est in the technology. Volantis has subsequently boosted its position, which now represents 1.8 per cent of the portfolio. By mid-December, the stock was above 100p, having cumulatively contributed 2.6 per cent to the fund’s value. Believing quantitative easing would drive down mortgage rates and that expansion of loan guar- antees would trigger more hous- ing sales, Mr Giles and Mr McCo- nkey saw a recovery play in Crest Nicholson. The UK homebuilder emerged from a private buyout financially sound, with an initial public offer- ing in early 2013 priced at £2.20. The managers bought at the offer- ing, believing the company was poised to exploit pent-up housing demand that would be unleashed by expansionary policies. By mid- December, the shares were trading above £3.50, having boosted fund returns by 1.7 per cent. Volantis’s performance is largely driven by long diversified posi- tions such as these. When manag- ers sense market uncertainty, they tend to ratchet back gross expo- sure. This strategy limited losses in 2008 to just 5.4 per cent – just one-quarter the decline suffered by the average hedge fund. Kawa Strategy: Opportunistic debt Manager: Daniel Ades When this Miami Beach-based fund started up as markets began melting down in autumn 2007, manager Daniel Ades admits he felt scared “shitless”. But it never showed in his per- formance. This opportunistic manager pro- ceeded to generate double-digit returns every year, averaging gains of 16.9 per cent, with low volatility, while turning in only six negative months through June 2013. We found a manager who jumped on deep-value opportuni- ties when much of the market was spurning these securities, holding on for only a few months and then selling when investors real- ised they had panicked. Such well-timed, shortly held purchases have limited the fund’s exposure to sell-offs. As a result, its maximum drawdown has been just 2.34 per cent. While the $238m fund has expo- sure to various asset classes, it is clear that the manager feels most comfortable trading debt. In fact, when asked why a so-called “opportunistic” fund failed to par- ticipate in one of the strongest bull markets ever seen, he says: “I saw greater risk-reward in fixed income”. Comparing his returns with the S&P 500 proved him right – every year. Kawa’s traditional trades include deep value (crisis- depressed bank and auction-rate preferreds), relative value trades (profiting from spread compres- sion between mispriced assets), and growth trades (where the market has underestimated for- ward valuations). Starting in June 2011, Mr Ades eventually built up a 4 per cent position in a basket of out-of-fa- vour, long-date California school district zero-coupon bonds. These bonds were caught up in the grow- ing fear of widespread municipal default, which hit California’s struggling debt especially hard. “Effective yields” had widened from 6 per cent in October 2010 to 7.5 per cent just before Mr Ades started buying. In selling off, investors had ignored the fact that these bonds were issued with voter approval. They were ringfenced obligations, specifically backed by the district property taxing authority. When fears eased and as “yields” fell below 6.5 per cent, Mr Ades sold out, delivering a 70 basis point boost to the fund. Mr Ades unlocks value by restructuring bonds. In March 2012, Kawa established a 6 per cent stake in a Brazos higher education asset-backed security, which was made up of senior and subordinate government-guaranteed student loans, private loans and cash. It paid around 60 cents on the dollar. Working with Brazos, Kawa cre- ated individual securities out of these constituent parts, and resold them for a gain of around 12 per cent in less than six months. Mr Ades has made some wrong investments, mostly involving equity. But he has reduced these losses significantly since his first year, which explains why the manager keeps his eyes trained on sound debt when it sells off. The secret of fund success is spotting a hidden opportunity Top funds Eric Uhlfelder and Jonathan Kanterman analyse the strategy of five selected funds Daniel Ades of Kawa is most comfortable trading debt FTfm – Hedge fund analysis Volantis’s Rob Giles and Adam McConkey rely on their knowledge of underanalysed smallcaps
- 3. FINANCIAL TIMES MONDAY JANUARY 6 2014 11 Perfin Investimentos Long Short Manager: Ralph Rosenberg Strategy: Equity market neutral/ cash plus Perfin derived a simple way to deal with Brazil’s fickle stock market to deliver consistent double-digit returns with low volatility and drawdowns. It combines substan- tial exposure to the country’s high overnight interest rates, which have averaged 10 per cent since the fund started in 2007, with targeted long and short equity positions, whose net exposure ranges between -10 per cent to 20 per cent. The latter has enhanced annual performance, ranging from 1 per cent to more than 21.5 per cent. The fund will sometimes under- perform the Bovespa, explains manager Ralph Rosenberg, as it did in 2009 when the index was up 83 per cent. But when stocks plummeted as they did in 2008 (down 41 per cent), the fund gained more than 10 per cent. Bot- tom line: Perfin’s cumulative returns have outperformed Brazil- ian shares 136 per cent vs -20 per cent, while the average Brazilian hedge fund has been flat. Monthly report and performance attribution documents reveal cash’s significant contribution to performance. The presentation doc- ument focuses on the equity investing strategy, which combines core and opportunistic trading, often involving the same stock. Dufry South America, the regional airport retail concession- aire, was an early core holding. In April 2010 the subsidiary was one of many absorbed by its Swiss parent. Consolidation has created a global leader that is capturing the benefits associated with the steady rise in passenger travel. Because the Swiss parent trades in São Paulo, the fund has retained its 2.5 per cent exposure. Over the past five years, annu- alised top-line growth has been running at 10 per cent and under- lying earnings growth at 13 per cent. Since consolidation, this has helped push shares up from R$150 ($63) to R$402 in mid-December, adding an average of 55bp a year to the fund’s performance. Cosan, another original core holding that also represents 2.5 per cent of the fund, was Brazil’s leading sugar cane and ethanol producer. Between 2009 and 2012, it decided to leverage its cash flow to transform itself through acqui- sitions into a transport and energy infrastructure and renewa- ble fuels leader. Though now burdened with R$9.8bn in debt, the market has rewarded Cosan’s synergies by pushing up the stock from R$25 to R$40 over the past four years. This has boosted fund returns by 2 per cent. Mr Rosenberg believes subsequent deleveraging should drive profitability and the stock. Foreign institutional investors would probably find the fund’s equity exposure low for a long/ short fund. While the performance fee is applied only to equity-related returns, some investors may balk at the management fee being applied to the fund’s hefty cash position. But the net results of this hybrid strategy are compelling. Quaesta Bond Global Select Strategy: Global macro Manager: Christian Graf von Strachwitz Perhaps the most critical thing one can say about this Frankfurt-based fund is that its name is a misno- mer. Since it started up in 2005 under the management of Chris- tian von Strachwitz, the fund has been macro focused, investing in equity indices, currencies and debt to achieve steady returns of more than 12 per cent a year. The fund’s annualised standard deviation has averaged 8.7 per cent over the past five years, and its worst drawdown was less than 11 per cent. Equally compelling is this $672m fund’s low correlation with leading benchmarks. It has been negatively correlated to the JPMorgan EMU 1-10 year bond index along with the Macro and CTA fund indices. Its equity tilt is captured in the fund’s modest cor- relation to the S&P 500 (0.32) and DJ Euro Stoxx 50 (0.43). Such nonconforming numbers come as no surprise once you understand the manager’s mantra. “Regardless of how attractive, we avoid crowded trades,” explains Mr von Strachwitz. His contrarian posture is achieved through inde- pendent research and analysis, which he says helps him identify where the market is heading. For instance, when the US gov- ernment periodically becomes bogged down in debt-ceiling cri- ses, Mr von Strachwitz has seen German Bunds rally. Quaesta saw an opportunity when it sensed the supercharged yen could not hold its high value during the summer of 2012. Strong European Central Bank support for the euro combined with Japanese monetary easing suggested upside in a long euro-yen trade. After just a couple of months, Quaesta closed out this position, adding 1.6 per cent to the fund. Around the same time, Mr von Strachwitz’s team believed Span- ish and Italian sovereigns were oversold on fears of collapsing domestic economies and systemic threat to the euro. Feeling the ECB would be compelled to support these markets, the fund started buying Spanish and Italian bonds. The trades received a boost when the ECB reiterated its defence of the euro and recommitted to its sovereign bond-buying pro- gramme. Steady bond appreciation ensued, enhanced by an interest- rate cut, which together added 4 per cent to the fund by mid-2013 when Mr von Strachwitz closed out these positions. Quaesta’s staff of 24 profession- als maintains 15-25 investments that last from several weeks to several months. They protect the fund’s downside through extensive daily stress testing and application of strict stop-losses to prevent indi- vidual trades from dragging down the fund by more than 1-3 per cent. So far, it has worked well. RiverNorth Capital Partners Strategy: Statistical arbitrage Managers: Patrick Galley and Stephen O’Neill Closed-end funds, the primary security RiverNorth trades, have been around for decades. There are around 600 such exchange traded funds, representing one out of five securities listed on the New York Stock Exchange, with no more than about 10 firms trading around the inefficiencies of this asset class. This is an obscure strategy, but Patrick Galley and Stephen O’Neill are proving the merits of trading in a less crowded space. Since starting up in August 2007, the managers have racked up annualised gains of more than 22.5 per cent a year through to June 2013, with a trailing five-year annualised standard deviation that is under 10 and a worst draw- down that is less than 8 per cent. Closed-end funds offer unique trading opportunities because their market prices deviate significantly from their net asset values. With such funds built around specific asset classes, their market prices are moved by underlying valua- tions and sentiment towards the asset class. Being able to go long and short, the managers rely on statistical arbitrage to identify discounts and premiums in market prices that they anticipate will change. With more than three-quarters of closed-end funds using leverage, which averages 30 per cent to boost yields of their dividend-pay- ing holdings, yield-starved inves- tors poured into these invest- ments. This pushed the portion of funds trading at a premium to 54 per cent as of September 2012. This seemed rich to the managers. By the spring, they saw their opportunity when Ben Bernanke, chairman of the US Federal Reserve, hinted tapering of QE was being considered. They assembled a basket of municipal, high-yield, emerging market and bank-loan funds that represented up to 52 per cent of RiverNorth’s gross short exposure as of September 2012. Between May and August of the following year the managers unwound this position. By the autumn, 90 per cent of closed-end funds were trading at discounts. The trade boosted the fund’s per- formance by 5 per cent. During the fourth quarter of 2012, fears about the pending fis- cal cliff hit covered call option funds, capping a year of reduced dividend payments as premium- writing income fell, having cre- ated a 15 per cent discount in many such funds. Seen as a temporary phenome- non, Mr Galley and Mr O’Neill established a 17 per cent long position in a basket of these funds by January 2013. The discount quickly closed as budgetary fears subsided. By September the man- agers unwound the bulk of the position, adding 3 per cent to returns. Without a down calendar year, having gained more than 21 per cent when markets collapsed in 2008, the managers have found a niche that significantly topped more familiar, crowded strategies. RiverNorth’s Patrick Galley and Stephen O’Neill are proving the merits of trading in a less crowded space Several years of performance is required to make a fair assessment of our thesis that investors can realise superior and operationally less risky returns through refined research and due diligence. But here is what we have found so far. With two years under our belts, the five original funds we selected in 2011 have almost doubled the performance of the average hedge fund, rising an average of 5.1 per cent a year versus the BarclayHedge Fund Index. They have also outperformed the MSCI EAFE Index, which was up 1.58 per cent. But we underperformed the S&P 500, which had gained an average of 12.77 per cent. Our topperforming funds were the Harvest SmallCap [long/short equity] Strategy (+10.65 per cent per annum) and the Steelhead Pathfinder convertible arbitrage fund (+8.21 per cent). Our worst and only cumulatively negative performance from 2011 was the Forum Global Opportunities [macro] fund (2.99 per cent), which was hurt by its high conviction short position of emergingmarket credits, which the manager still thinks will play out. Three of the five funds we selected in 2012 have performed very well, both relative to their strategies and in absolute terms over the past 12 months through June 2013. GAM Talentum Emerging Long/Short Equity fund paced the way, rising more than 15 per cent, followed by the Parus [long/short equity] fund, which was up more than 12 per cent. Talentum’s gains were founded in the fund’s predominantly long positions, spread across a variety of countries and industries. And potentially damaging currency exposure was effectively hedged. The performance of developed marketfocused Parus was driven by its bullish bottomup approach, especially in financials, which accounted for 70 per cent of performance. Two other funds we cited were hurt by their defensive postures. LJM Preservation and Growth, an options strategy fund that had an extremely consistent record throughout its sixyear history, was down 7.7 per cent, mainly due to its performance in May 2013, when it lost an extraordinary 9 per cent. Omni Macro fund’s conviction that quantitative easing was setting up a bearish scenario for a richly priced market proved costly as stocks continued to rally, generating a loss of nearly 6 per cent over the trailing year. More details on our performance is available online Record so far Tracking the performance of selected funds from previous years FTfm – Hedge fund analysis Selected funds Source: BarclayHedge Total return indices (rebased) Jun 2011 2012 Jun2013 800 900 1000 1100 1200 1300 Barclay Hedge Fund Index MSCI EAFE Gross Index (USD) S&P 500 Total Return Index FT Select 5 Hedge Funds (2011) Christian von Strachwitz’s Quaesta invests with a contrarian posture