Introduction
The Eurekahedge North American Hedge Fund Index, which measures the performance of hedge funds allocating to the Eurekahedge North American Hedge Fund Index, which measures the performance of hedge funds allocating to North American markets, witnessed its best performance on record in 2009, posting gains of 23.45%[1] through the year as strong rallies in the underlying markets across different asset classes worked in favour of the industry. This is a significant outperformance over the global average (19.29%) as well as the European hedge funds, which gained 21.69% during the same time period. When compared to the underlying markets, North American hedge funds show a remarkable trend – since December 2006, the Eurekahedge North American Hedge Fund Index is up 21% while the S&P 500 is down more than 21%.
After suffering massive redemptions from August 2008 to April 2009, the region’s hedge fund industry started attracting capital again in May 2009. In the last eight months of the year, North American hedge funds gained US$43 billion in positive net asset flows, ending 2009 with assets under management standing at US$965 billion, up 14% from April 2009. The region accounts for the 64% of the global hedge fund industry, down a marginal amount from about 67% in 2008.
Figure 1 shows the growth in the number of hedge funds and assets under management in North American funds since 2000.
Figure 1: Industry Growth over the Years
2009 was a year of mixed fortunes for the region’s hedge fund industry. The sector saw 14% of assets withdrawn in the first four months of the year, with the total AuM figure dropping below US$850 billion in April. Since then, however, we have seen an impressive rally and currently, AuMs of North American hedge funds stand at the same level as that of December 2008 at just under US$1 trillion. Managers have posted strong gains through performance while the trend of redemptions was also reversed in May as investor confidence returned and risk appetites gained strength.
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Asset Flows
Table 1 shows the monthly changes in the North American hedge fund assets due to performance and net asset flows over the last two years. Assets under management fell by US$241 billion in 2008 while in the period of July 2008 to April 2009, the total assets was almost US$400 billion – a 32% decrease from the all-time high reached in June 2008. However, the sector has posted a significant recovery both in terms of performance and asset flows since May 2009, bringing the current size of the North American hedge fund universe back up to US$965 billion.
Table 1: Monthly Asset Flows across North American Hedge Funds
Month
|
Assets at Start
|
Net Growth (Perf)
|
Net Flows
|
Assets at End
|
Jan-08
|
1,189
|
(17)
|
2
|
1,175
|
Feb-08
|
1,175
|
12
|
12
|
1,200
|
Mar-08
|
1,200
|
(19)
|
23
|
1,204
|
Apr-08
|
1,204
|
11
|
(8)
|
1,207
|
May-08
|
1,207
|
19
|
0
|
1,225
|
Jun-08
|
1,225
|
0
|
22
|
1,247
|
Jul-08
|
1,247
|
(26)
|
7
|
1,229
|
Aug-08
|
1,229
|
(16)
|
(5)
|
1,208
|
Sep-08
|
1,208
|
(46)
|
(22)
|
1,141
|
Oct-08
|
1,141
|
(37)
|
(52)
|
1,052
|
Nov-08
|
1,052
|
(5)
|
(29)
|
1,018
|
Dec-08
|
1,018
|
2
|
(45)
|
975
|
2008
|
1,189
|
(120)
|
(94)
|
975
|
Jan-09
|
975
|
7
|
(63)
|
919
|
Feb-09
|
919
|
(3)
|
(13)
|
903
|
Mar-09
|
903
|
(1)
|
(26)
|
876
|
Apr-09
|
876
|
8
|
(34)
|
849
|
May-09
|
849
|
23
|
1
|
873
|
Jun-09
|
873
|
(0)
|
7
|
880
|
Jul-09
|
880
|
13
|
(0)
|
893
|
Aug-09
|
893
|
8
|
11
|
912
|
Sep-09
|
912
|
17
|
13
|
942
|
Oct-09
|
942
|
0
|
5
|
947
|
Nov-09
|
947
|
10
|
6
|
964
|
Dec-09
|
964
|
1
|
1
|
965
|
Note: All figures in US$ billion.
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Source: Eurekahedge
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The distinct trend observed in Table 1 shows a strong correlation between a month’s negative performance and net redemptions in the following one or two months. In the months following April 2009, the trend is equally true for net inflows that have followed months of strong positive performance returns. However, the positive flows witnessed since May 2009 are not strong enough to offset the redemptions seen during the first four months of the year, partly because a proportion of the amount withdrawn in early 2009 was from funds which had gated or suspended outflows in the last quarter of 2008.
Figure 2 displays the correlation between asset flows and performance – the red line tracks the 3-month moving average of net flows (from Table 1) displaced by two months while the blue line shows the Eurekahedge North American Hedge Fund Index.
Figure 2: Eurekahedge North American Hedge Fund Index vs Displaced Moving Average Net Flows
This seems to suggest that investors have subscribed two months after periods of positive performance and redeemed two months after periods of negative performance at corresponding magnitudes to the underlying performance, ie the more positive the performance, the larger the subsequent subscriptions and vice versa. Whether this truly suggests that investors are “trend-following” or a simple statistical manipulation is open to some debate.
Funds by Size
The past few years have witnessed significant changes in the composition of the North American hedge fund sector in terms of fund sizes. As shown in Figure 3, the number of funds managing more than US$100 million grew steadily from 2005 until 3Q2008 as stable returns for most of this period helped funds progressively outgrow their initial AuM ranges. This trend was, however, reversed as the financial crisis took its toll on the regional managers.
In the 3Q2008 to 3Q2009 period, the number of funds with more than US$1billion in assets declined by two-thirds while the number of funds with less than US$50 billion increased to account for more than 50% of the region’s hedge funds amid performance-based losses as well as widespread redemptions. Furthermore, the increase in the number of smaller hedge funds (US$20 million or less) is also caused by a significant number of funds which were started in 2009 by professionals who left investment banks, proprietary trading desks and other financial institutions.
Figure 3: Changes in the Composition of the Fund Population by Fund Sizes
Funds by Investment Strategy, Investment Region and Head Office Location
Investment Strategy
Among the strategic mandates, although long/short equities remain the most dominant investment style in terms of assets under management, it has lost 8% of its share since the end of 2007. The strategy had reached its highest share of North American hedge fund assets (39%) in the first half of 2007; however, the risk aversion triggered by the credit crunch in 2007 ended the year with capital exiting the high-risk asset classes. Further turmoil in the markets during 2008 due to the meltdown of some large US financial institutions, as well as the ban on short-selling imposed by financial regulators, led to further losses by long/short equity managers, which in turn resulted in greater withdrawals from the funds.
It is interesting to note here that with the increased redemption pressure from investors, managers were forced to liquidate their positions in a declining market, which further contributed to their performance-based losses. As such, the 8% decline in long/short managers’ share of North American hedge fund assets was not only due to the flight of capital from the strategy but also due to greater performance-based losses in 2008 – North American long/short managers’ lost 16.7% during 2008 while the average North American hedge fund was down 8.9%.
On a side note, when compared to other regions, long/short equity funds form a smaller chunk of the North American hedge fund sector because the region is a more sophisticated market and has the longest-running hedge funds. Additionally, there is a greater availability of more exotic instruments such as derivatives and convertibles. Also, since it is the most transparent market with the most abundance of materials available on stocks, it is harder to look for opportunities that others have not already spotted.
The strategies which have gained market share in North American hedge funds over the years are CTA/managed futures and multi-strategy funds as investors look to diversify from the traditional asset classes. Additionally, the strong performance of CTA/managed futures managers in 2008 (up 28%) contributed to the increase in their share of the pie while also drawing strong capital flow during 2009 – the total assets under management of CTA/managed futures hedge funds in North American grew by almost 30% from December 2007 to December 2009.
Figures 4a-4c: Changes in the Strategic-Mix of North American Hedge Funds by Assets
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Investment Region and Head Office Location
Most North America-investing hedge fund managers are based in the United States, which is the oldest hedge fund centre, boasting the biggest market and the largest number of investors, administrators and service providers. In addition, the US market has traditionally offered the greatest number of different asset classes and products, hence, attracting a greater number of hedge fund managers. Furthermore, US-based managers have always enjoyed a great deal of flexibility due to being relatively loosely regulated compared to their Europe- and Asia-based counterparts.
However, as predicted by Eurekahedge in the July 2009 Key Trends in North American Hedge Funds report[2], the post-financial crisis world has seen some changes in the distribution of North American hedge fund manager locations. Following the collapse of major US financial institutions, as well as major scandals (Madoff) and the subsequent pressure that hedge funds have come under, we see a reduction in the percentage of North American hedge funds based in the US. In the six months from July 2009 to December 2009, the number of funds based in the US has reduced from 80% to 77% while there has been a subsequent increase in the funds managed from offshore centres.
Figures 5a-5b: North American Hedge Funds by Manager Location and Geographical Mandate
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In terms of geographical mandates, North America continues to dominate the sector; however, global funds have been increasing their share. Since end-2008, the share of global-mandated funds has increased by 1.5% while over the longer term, this figure stands at almost 10% since 2005. The increase in global-investing funds is seen due to various reasons:
a) Investors are looking to diversify their portfolios away from the traditional markets and into developing and frontier regions.
b) Markets in Latin America, Asia and Eastern Europe are expected to provide greater investment opportunities over the short to medium terms.
c) Macro and CTA/managed futures funds (both of which employ a global geographical mandate) were the only strategies in positive territory through 2008; hence, both of these strategies subsequently attracted significant amounts of capital in 2009.
Performance Review
North American hedge funds have outperformed other developed market hedge funds for three consecutive years while the 2009 return of 23.45% is the best return on record for the Eurekahedge North America Hedge Fund Index.
Although regional funds were slightly behind the underlying markets as the S&P 500 gained 26% during the year when considered in the longer term, North American managers have significantly outperformed the markets. In the three years since December 2006, the Eurekahedge North American Hedge Fund Index is up 21% while the S&P 500 is down more than 21%.
Furthermore, hedge funds in North America have also fared better as compared with the regional absolute return funds[3] and funds of hedge funds – Figure 6 shows the relative performance of these three types of alternate investment vehicles since December 2007.
Figure 6: Performance of North American Hedge Funds vs Other Alternative Investment Vehicles
Table 2: Performance of North American Hedge Funds vs Other Alternative Investment Vehicles
(since 2006)
Eurekahedge North America Absolute Return Fund Index
|
Eurekahedge North American Hedge Fund Index
|
Eurekahedge North America Fund of Funds Index
| |
Annualised Returns
|
-6.11
|
5.61
|
-6.07
|
Annualised Standard Deviation
|
17.60
|
8.06
|
7.88
|
Sharpe Ratio
|
-0.57
|
0.20
|
-1.28
|
Source: Eurekahedge
|
North American hedge funds have done relatively well during the last two years, having outperformed their multi-fund counterparts as well as North American long-only absolute return funds. Not only did hedge funds achieve the highest annualised returns, they have also achieved greater consistency as shown by their better Sharpe Ratios in Table 2.
Moreover, North American hedge funds have outperformed funds from most of the other geographical mandates over the past few years and have done so consistently with the least volatility in their returns. Figure 6 shows the returns of Eurekahedge regional hedge fund indices from December 2007 to December 2009. One of the reasons for this average consistent performance is that the North American hedge fund industry has a mixture of funds employing different investment strategies unlike the emerging markets hedge fund space which is dominated by long/short equity managers.
Figure 7: Hedge Fund Performance by Geographical Mandate
Table 3: Hedge Fund Performance by Geographical Mandate (since end-2007)
Eurekahedge Asian Hedge Fund Index
|
Eurekahedge European Hedge Fund Index
|
Eurekahedge Latin American Offshore Hedge Fund Index
|
Eurekahedge North American Hedge Fund Index
| |
Annualised Returns
|
-0.24
|
-1.78
|
3.49
|
5.85
|
Annualised Standard Deviation
|
11.81
|
10.73
|
11.05
|
8.06
|
Sharpe Ratio
|
-0.36
|
-0.54
|
-0.05
|
0.23
|
Source: Eurekahedge
|
Strategic Mandates
Figure 8 illustrates the 2009 and 3-year annualised returns of North American hedge funds across the various investment strategies.
Figure 8: 2009 Returns vs Annualised Returns for Various Strategies
Within the North American hedge fund space, all strategies returned positive in 2009 while hedge funds investing in distressed debt provided the best returns – the Eurekahedge North America Distressed Debt Hedge Fund Index gained a massive 48.1%[4] through the year while event driven hedge funds also gained a remarkable 49.0%[5] through 2009.
Distressed debt managers capitalised on the many opportunities seen in the high-yield space throughout the year as the Merrill Lynch High Yield Index gained more than 50%. The year started with good corporate debt trading at deep discounts while new bond issues were priced for an economic depression scenario; however, the sector provided excellent returns to the managers as the global economy improved in the later months of the year. Credit analyst upgrades also helped boost the values of the distressed debt issues. Event driven funds also performed strongly in 2009 given the low-value opportunities available to companies with strong balance sheets while CTA/managed futures funds did well on a 3-year basis as their 2008 returns still outpaced their weak performance in 2009.
Geographic Mandates
Figures 9a-9b: Performance of North American Hedge Funds by Geographical Mandate
(as at May 2009)
In terms of geographical mandates, North America-specific managers outperformed their global-investing counterparts through 2009. This is primarily because a good number of the global funds investing in the region are CTA/managed futures and macro funds – both of which have underperformed the average North American hedge fund this year. However, on a 3-year annualised return basis, global-investing funds are at par with the North America-dedicated funds as CTA/managed futures and macro funds fared positively in 2008 while all other strategies ended the year in negative territory.
New Developments in the North American Hedge Fund Industry
Following the collapse of some major financial institutions and the consequent disarray in the financial markets, the finance industry landscape has started changing in response to the demand for more regulations and greater emphasis on risk management, especially in the case of hedge funds. Because of these, North American hedge funds are in a transitioning process to a new normal and we discuss some of the changes in the industry as follows.
The tables below show the changes in the average management and performance fees of new North American hedge funds launched over the last five years.
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Although the average annual management fees have not changed significantly as they are reasonable and competitive with the fees charged by other investment vehicles like mutual funds, there has been a significant change in the average performance fees of North American funds launched in 2009. Similar to the trend in mutual funds, where investors’ demand for lower fees resulted in the creation of ETFs and a decline in the average mutual fund fee, hedge funds launched in 2009 have also responded to recent investor demands by lowering their performance fees from an average of 19.9% to 16.6%.
In addition to the changes in the fee structures, we have seen some significant trends in the administrator landscape, given the post-Madoff regulatory requirements making it virtually mandatory for hedge funds to have third-party administrators. The Bernard Madoff fraud had a tremendous impact on defining the North American hedge fund sector after the financial crisis.
It is important to note that Bernard Madoff’s ‘fund’ did not have a proper infrastructure; he used internal service providers, his accounting was conducted by a 3-person firm that no one had ever heard of and he did not have any third-party administrators or custodians. The aftermath of the fraud witnessed calls for greater regulations on hedge funds and no investor was ready to invest with managers who did not have third-party administrators and the proper risk controls in place. Furthermore, some of the largest institutional investors in the industry demanded that the hedge funds which they invest in (including some of the largest names in the industry) should get third-party administrators – barring which they threatened to withdraw their investments. Currently, among the 3,247[6] funds that make up the Eurekahedge North American Hedge Fund database, about 70% have appointed third-party administrators. The number of administrators has risen 35% from 260 in 2007 to 350 in 2009 although out of these 350 administrators, 186 have only one client. It is interesting to note, however, that the demands for tighter regulations have been far less an issue in the Asian hedge fund space where most of the funds have a “top 10” administrator.
Another significant change in North American hedge funds is observed in the prime brokerage space. After the collapse of Lehman Brothers in 2008, hedge funds started moving assets off prime brokers’ balance sheets and to traditional custody players like State Street, Bank of New York and Northern Trust. Furthermore, hedge funds also started diversifying among the different brokers to protect themselves against counter-party risk, which had previously been a consideration only for the prime brokers as a measure against default by a hedge fund.
Another key development in the North American hedge fund industry is the introduction of UCITS-compliant funds. The UCITS standard is seen as one of the solutions to investors seeking more transparency on hedge funds and seems to be gaining traction with North American hedge funds even though the directive was set up by the European Union. In 2009, 7% of all new hedge fund launches in North America were UCITS-compliant – this is seen as an anticipation of greater regulations as well as a move to expand investor base. The UCITS framework allows funds to be marketed to investors across Europe, such as pension funds in individual countries – a segment that North American hedge funds previously could not target. Furthermore, being UCITS-compliant would also help smaller North American hedge funds to raise more capital as it would give them a much larger “tick” in investors’ due diligence questionnaires. Currently, 21% of the UCITS-compliant funds tracked by Eurekahedge are located in North America. As this sector of the global hedge fund industry grows, new developments, asset flows and performances of UCITS funds will make an interesting study – our current data shows that UCITS funds have performed on par with global averages over 2009 suggesting that there are no performance disadvantages in allocating to a UCITS-compliant hedge fund versus a traditional offshore hedge fund. Watch this space for more information on UCITS hedge funds as Eurekahedge launches the Eurekahedge UCITS Hedge Fund Database towards the end of 1Q2010.
In Closing
Given the challenges facing the North American hedge fund industry at the start of the year, the industry recovered remarkably to deliver its best performance on record. Managers have also consistently outperformed other developed regions over the past few years and going forward, we believe that managers in the region will continue to be among the better performers.
The region continues to form the bulk of the global hedge fund sector by both number of funds and assets managing more than 65% of the total assets allocated to hedge funds across the world while also remaining the location of choice for more than 50% of managers. Looking forward, we believe that the region will continue to attract capital as the US market offers managers the widest choice of instruments and derivatives in an environment where investors are looking to increasingly diversify their portfolios. Also, there is an increasing number of US-based hedge funds which offer exposure to global and emerging markets which is another key requirement of investors. Furthermore, the US, being the oldest of hedge fund centres, houses the most experienced managers having proven track records of delivering alpha during a multitude of market environments over the past decades.
In addition to the above, the stress laid on tightening regulations will also make it easier for managers to raise capital from large institutional investors as well as attracting capital from those private investors who have had concerns about investing in unregulated funds.
[3] A long-only absolute return fund is a fund that takes only long positions, seeks undervalued securities and reduces volatility and downside risk by holding cash, fixed income or other basic asset classes.
