Introduction
After posting strong growth in 2009 and 2010, European hedge funds have faced some challenging times in 2011. The Eurekahedge European Hedge Fund Index was down 5.54% November YTD while assets under management (AuM); which had crossed the US$400 billion mark earlier this year, fell back to US$380 billion.
The region’s hedge fund sector has witnessed significant changes over the last 10 years, going through a cycle of growth and decline, followed by a period of reorganisation and consolidation in the industry. Between 2002 and 2007, European hedge funds underwent exponential growth, both in terms of number of funds and AuM reaching a maximum size of US$472.8 billion by October 2007, with the total number of funds crossing the 3000 mark. The global financial crisis wiped out a significant part of the industry and between January 2008 and March 2009, the assets in European hedge funds declined by nearly 40%.
Figure 1a: Industry growth since 2000
By the end of 1Q 2009, the size of the industry had shrunk to US$293.6 billion, due to the combined effects of performance-based losses and widespread redemptions. In the following 12 months, the industry witnessed a remarkable turnaround, posting excellent returns and also attracting significant asset flows. Since then, European hedge funds have faced some challenging times with net losses and redemptions amid the sovereign debt crisis.
|
Figure 1b: Industry growth since April 2009
|
Asset flows
The trend of redemptions ended in April 2009 as the global marketplace posted a strong recovery and in the last eight months of 2009, European hedge funds attracted US$30.2 billion from investors while adding US$22.4 billion through positive performance. The sector saw exceptional performance-based gains in 2010, adding US$25.8 billion to total industry assets; however, asset flows were weak during the year as the European debt crisis took a toll on investor sentiment.
Positive flows from investors, as well as some performance-based gains during the first few months of 2011, helped the industry to cross the US$400 billion mark. By mid-year, the sovereign debt situation came to the fore once again with investors becoming increasingly risk averse and preferring to hold on to their cash. Additionally, a weak macroeconomic outlook led to fears of slowing global growth. The region’s hedge funds saw net outflows of US$21 billion from May to October while facing portfolio losses of US$7.6 billion, bringing the total size to US$380 billion.
Table 1: Monthly asset flows in European hedge funds
Month
|
Net growth (performance)
|
Net flows
|
Assets at end
|
Jan-09
|
(0.2)
|
(20.5)
|
308.5
|
Feb-09
|
(0.7)
|
(10.3)
|
297.4
|
Mar-09
|
0.7
|
(4.5)
|
293.6
|
Apr-09
|
4.2
|
(3.9)
|
293.9
|
May-09
|
7.9
|
2.6
|
304.4
|
Jun-09
|
(1.3)
|
4.2
|
307.3
|
Jul-09
|
3.5
|
2.5
|
313.3
|
Aug-09
|
4.4
|
5.8
|
323.5
|
Sep-09
|
6.1
|
7.5
|
337.2
|
Oct-09
|
(1.7)
|
6.1
|
341.5
|
Nov-09
|
2.1
|
2.2
|
345.8
|
Dec-09
|
1.3
|
(0.6)
|
346.5
|
2009
|
26.3
|
(8.9)
|
346.5
|
Jan-10
|
0.3
|
(2.0)
|
344.8
|
Feb-10
|
(0.0)
|
(1.6)
|
343.1
|
Mar-10
|
7.2
|
1.1
|
351.5
|
Apr-10
|
1.8
|
(1.8)
|
351.4
|
May-10
|
(5.7)
|
(5.7)
|
340.0
|
Jun-10
|
(0.6)
|
(3.2)
|
336.2
|
Jul-10
|
2.9
|
8.4
|
347.5
|
Aug-10
|
1.9
|
(0.6)
|
348.8
|
Sep-10
|
6.0
|
7.7
|
362.6
|
Oct-10
|
4.9
|
4.9
|
372.4
|
Nov-10
|
(1.3)
|
(3.7)
|
367.4
|
Dec-10
|
8.4
|
0.5
|
376.3
|
2010
|
25.8
|
4.0
|
376.3
|
Jan-11
|
0.1
|
6.0
|
382.4
|
Feb-11
|
2.8
|
7.0
|
392.2
|
Mar-11
|
(0.1)
|
7.2
|
399.3
|
Apr-11
|
4.9
|
12.3
|
416.5
|
May-11
|
(3.2)
|
(2.0)
|
411.2
|
Jun-11
|
(3.2)
|
(1.0)
|
407.0
|
Jul-11
|
1.2
|
(2.8)
|
405.4
|
Aug-11
|
(6.1)
|
(3.0)
|
396.3
|
Sep-11
|
(5.1)
|
(11.5)
|
379.7
|
Oct-11
|
1.2
|
(0.8)
|
380.1
|
Source: Eurekahedge
While the fortunes of European hedge funds have been mixed over the last three years, developments in the industry have led to the popularisation of UCITS III[3] hedge funds. These regulated vehicles have witnessed exponential growth, both in fund population as well as AuM over the last three years. Figure 2a shows how the comparative growth of non-UCITS III European hedge funds and European UCITS III hedge funds; which clearly show that post-2008, UCITS III hedge funds have grown to account for a significant portion of total industry assets – nearly 29%. Figure 2b shows the comparative growth in non-UCITS hedge funds and UCITS III hedge funds over the last six years – the assets in UCITS III hedge funds have increased nearly tenfold while those in non-UCITS hedge funds have witnessed a decline. Growth in UCITS III hedge funds has been triggered by increasing investor interest post-financial crisis, due to the regulatory framework’s strict guidelines on transparency, redemption frequency, leverage and risk management – all of which are important concerns for hedge fund investors, especially in the post-2008 world.
Figure 2a: AuMs of non-UCITS III European hedge funds and European UCITS III hedge funds since January 2006
Figure 2b: Comparative asset growth in non-UCITSIII European hedge funds and European UCITSIII hedge funds since January 2006
Redemption notice
Table 2 displays the average redemption notification period of European hedge fund launches over the last six years. The significant decrease displayed in the redemption period is attributed to two main reasons:
<![if !supportLists]>a) <![endif]>Hedge fund investors were unable to withdraw their capital from falling markets in 2008 because a number of managers had put up gates and suspended redemptions. Since then investors have demanded better liquidity terms from hedge funds, and managers have moved to address this concern in order to attract assets.
<![if !supportLists]>b) <![endif]>The growing popularity of UCITS III hedge funds has resulted in an increasing fund population. One of the most attractive features of UCITS III funds is that they offer significantly greater liquidity to investors, which has further helped them to raise assets while also lowering the average redemption notification period.
Among the different strategies, CTA/managed futures funds have the lowest notice period, as the strategy tends to be the most liquid. Among other mandates, multi-strategy funds have the longest redemption notification period, primarily because there are very few UCITS III multi-strategy hedge funds.
Table 2: Average redemption notice of European hedge funds by strategies (days)
Year
|
Average of all funds
|
Arbitrage
|
CTA/managed futures
|
Event driven
|
Fixed income
|
Long/ short equities
|
Macro
|
Multi-strategy
|
2006
|
33.8
|
27.7
|
9.9
|
77.9
|
8.8
|
33.3
|
25.5
|
42.0
|
2007
|
30.7
|
45.1
|
17.4
|
94.2
|
9.9
|
30.9
|
17.5
|
31.2
|
2008
|
31.7
|
16.0
|
9.7
|
40.7
|
29.9
|
40.5
|
19.0
|
33.4
|
2009
|
25.2
|
8.6
|
17.9
|
46.4
|
32.3
|
21.0
|
16.5
|
27.0
|
2010
|
15.9
|
16.7
|
8.3
|
38.3
|
25.4
|
10.5
|
13.8
|
29.3
|
2011
|
14.0
|
15.5
|
9.3
|
15.2
|
20.6
|
12.8
|
14.0
|
28.8
|
Source: Eurekahedge
Leverage
The amount of leverage employed by European hedge funds has also witnessed a decline. Before 2009, the average leverage used by new launches was nearly 320% (3.2 times) while from 2009 onwards this figure has remained below 300%. This is partially explained by the strong launch activity in UCITS III hedge funds, while new hedge fund launches in general have stricter risk management protocols which limit the leverage employed.
Table 3: Average leverage utilised by European hedge fund launches since 2004
Launch year
|
Average leverage (%)
|
2004
|
300.3
|
2005
|
330.7
|
2006
|
283.8
|
2007
|
348.3
|
2008
|
322.3
|
2009
|
275.8
|
2010
|
279.5
|
2011
|
296.9
|
Source: Eurekahedge
Launches and closures
Growth in the European hedge fund population has remained positive over the last four years, despite the global financial crisis. The drying up of liquidity, market turbulence leading to losses and unprecedented redemption pressure in 2008, spiked up the fund attrition rate in 2008 and it remained high in 2009. However, launch activity picked up strongly over the last two years, primarily on the back of demand for UCITS III hedge funds. This trend of healthy launch activity has continued in 2011, with nearly 353 new funds launched during the year. Figure 3b shows how the proportion of UCITS III hedge fund launches has increased over the last few years.
Figure 3a: Launches and closures of European hedge funds since 2005
Figure 3b: UCITS III and non-UCITS launches of European hedge funds since 2005
Fees
Table 4 shows the average fees of European hedge funds launched since 2004, and also provides a breakdown between traditional hedge funds and UCITS III hedge funds. Since the financial crisis and the fall in assets of European and global hedge funds, there have been increasingly vocal calls by investors for lower fees charged by hedge fund managers. Although average management fees have remained consistent; primarily because they are in line with the management fees of other investment vehicles such as mutual funds, the performance fees of hedge funds have varied over the years. The most significant drop in the performance fees occurred in 2008, when managers, struggling to raise cash for their funds, started to take measures to attract greater capital.
It should be noted that while the average performance fees of non-UCITS hedge funds is now back above 19%, the average performance fees of UCITS III hedge fund have also started to increase. This is attributed to an increasing number of established hedge fund firms launching the UCITS compliant versions of their funds, and hence maintaining a similar fee structure.
Table 4: Average fund of fund fees by launch year
Year
|
All European Hedge funds
|
UCITS III hedge funds
|
Non-UCITS hedge funds
|
Average performance fee (%) of launches
|
Average management fee (%) of launches
|
Average performance fee (%) of launches
|
Average management fee (%) of launches
|
Average performance
fee (%) of launches
|
Average management fee (%) of launches
|
2006
|
18.6
|
1.61
|
15.63
|
0.90
|
18.79
|
1.68
|
2007
|
18.32
|
1.64
|
11.96
|
1.17
|
18.92
|
1.62
|
2008
|
17.58
|
1.59
|
11.69
|
1.17
|
19.08
|
1.70
|
2009
|
17.16
|
1.61
|
15.57
|
1.40
|
17.95
|
1.68
|
2010
|
17.89
|
1.65
|
17.05
|
1.50
|
19.57
|
1.78
|
Oct-11
|
17.87
|
1.44
|
17.42
|
1.32
|
19.18
|
1.80
|
Source: Eurekahedge
Fund sizes
Comparing the number of funds in the different size categories, between October 2007 when the industry was at its peak, and presently, the most significant difference is the increase in the proportion of funds with less than US$20 million in assets. During the 2008 to 2009 financial crisis, a number of funds lost their assets either through performance, outflows, or both, and were ‘demoted' into lower AuM categories. Additionally, the capital raising environment has remained tough in 2011; hence smaller funds and new launches have struggled to raise their asset base.
Figures 4a-4b: A comparative breakdown of European hedge funds by fund size
Strategic mandates
In terms of strategic mandates, the most significant change observed is the 14% decrease in the share of assets allocated to long/short equity funds, as these funds suffered the large losses in 2008 & 2011, also witnessing heavy redemptions. On the other hand, managers employing strategies in the bonds space have seen their share of European hedge fund assets increase. The combined share of fixed income, relative value and arbitrage hedge funds increased from 20% of the assets in October 2007 to 26% in October 2011. CTA/managed futures funds have also gained share due to their performance in 2008, when the average European CTA/managed futures fund was up 2% while the Eurekahedge European Hedge Fund Index declined by nearly 18%. Additionally, in light of this performance CTA funds have attracted significant capital since 2009.
Figures 5a-5b: Strategic mandates by AuM
Geographic mandates
Figures 6a-6b: Geographic mandates by AuM
Funds investing globally command the largest share of European hedge fund assets, as most European funds invest in North America and Asia in addition to Europe, hence employing a global mandate. The share of globally investing funds has increased over the years primarily because of the better performance of globally mandated funds through the financial crisis, as well as increasing interest from investors looking for diversification post-financial crisis. The current sovereign debt situation in Europe has further tilted the asset flows in the favour of global investments and we expect the share of globally investing hedge funds to grow further in the coming six months.
Head office location and domiciles
London remains as the location of choice for 46% of the managers, despite speculations over the last few years that a number of managers will move their head offices to Switzerland in the wake of new taxation laws in the UK. In fact the population of UK-based managers has increased from 43% in 2009, which is attributed to new fund launches as well as an increasing number of existing managers launching their UCITS III platforms. For new managers, London offers a wide range of service providers and a large hedge fund investor base, while the attraction for UCITS III hedge funds is that UK investors are familiar with the UCITS III framework and are a ready source of capital.
The exceptional growth of UCITS III hedge funds has effected a significant change in the breakdown of European hedge fund domiciles. Although Cayman Islands domiciled funds still account for nearly 35% of population, their share is down from more than 60%. The primary reason for this is the requirement for UCITS III hedge funds to have an onshore European domicile, as such, a significant number of European hedge funds have changed their domiciles to onshore locations while most of the new launches are domiciled within Europe.
Figure 7a:
Head office location by number of funds
|
Figure 7b:
Domiciles by number of funds
|
Prime brokers
Tables 5a-5b: Market share of prime brokers by AuM
December 2008
|
Prime Broker
|
Market Share
|
Morgan Stanley
|
19.63%
|
Goldman Sachs
|
11.86%
|
JP Morgan (Bear Stearns)
|
5.91%
|
Lehman Brothers
|
5.78%
|
Deutsche Bank
|
5.46%
|
UBS
|
5.11%
|
NewEdge Financial
|
4.43%
|
Credit Suisse
|
3.65%
|
Bank of America (Merrill Lynch)
|
3.30%
|
Barclays
|
2.98%
|
Others
|
31.89%
|
|
October 2011
|
Prime Broker
|
Market Share
|
Morgan Stanley
|
16.9%
|
Goldman Sachs
|
14.3%
|
Credit Suisse
|
12.8%
|
Deutsche Bank
|
10.8%
|
JP Morgan
|
9.9%
|
UBS
|
8.6%
|
Newedge Financial
|
5.3%
|
Citibank
|
4.6%
|
Barclays
|
4.3%
|
Bank of America (Merrill Lynch)
|
3.0%
|
Others
|
9.4%
|
|
Source: Eurekahedge Source: Eurekahedge
European hedge funds have sought to partner with as well as diversify among well established brokers in the wake of financial crisis. The most significant change observed over the last three years is the decrease in the share of prime brokers in the ‘Others’ category – from 31.89% to 9.4%. This was due to the shift towards more well-known prime brokers in the wake of the financial crisis as a measure of risk-control. Furthermore, the share of the top five prime brokers also shows more equitable distribution, primarily due to recognition by hedge fund managers of the counterparty risk posed by prime brokers; highlighted by the crash of Lehman Brothers. In the wake of the financial crisis, many hedge funds chose to diversify their assets among two or more prime brokers which resulted in greater distribution among the top five.
Administrators
Tables 6a-6b: Market share of administrators by AuM
December 2008
|
Administrator
|
Market Share
|
HSBC
|
14.16%
|
Citigroup
|
13.65%
|
CITCO
|
9.63%
|
GlobeOp
|
6.54%
|
Northern Trust
|
5.61%
|
CACEIS
|
5.14%
|
JP Morgan
|
4.45%
|
RBC Dexia
|
4.11%
|
Custom House
|
3.76%
|
Others
|
33.72%
|
|
October 2011
|
Administrator
|
Market Share
|
CITCO
|
14.0%
|
State Street
|
11.4%
|
GlobeOp
|
9.3%
|
HSBC
|
9.0%
|
Citigroup
|
6.8%
|
RBC Dexia
|
4.2%
|
JP Morgan
|
3.4%
|
Prime Fund Solutions
|
3.4%
|
CACEIS
|
2.8%
|
Others
|
35.7%
|
|
Source: Eurekahedge Source: Eurekahedge
Tables 4a-4b illustrate the change in European hedge fund market shares among administrators since December 2008. Unlike the prime broker landscape, there is not as much change in the market shares of administrators. CITCO has gained more market share primarily because the funds which they serve have increased in AuM while GlobeOp has increased market share through an acquisition. Some European hedge funds have separated their custodian function from their administrators which resulted in banks losing a portion of their market share. Smaller administrators in the ‘Others’ category remain above 30%, highlighting the competitive nature of the industry.
Performance review
Figure 8: Performance of European hedge funds and other investment vehicles
Table 7: Performance of European hedge funds and other investment vehicles
|
Eurekahedge European Hedge Fund Index
|
Eurekahedge Europe Absolute Return Fund Index
|
MSCI AC
Europe Local
|
Eurekahedge Europe Fund of Funds Index
|
6 month returns
|
(6.8%)
|
(13.1%)
|
(15.9%)
|
(6.9%)
|
3 year annualised returns
|
6.7%
|
7.6%
|
4.1%
|
0.8%
|
3 year annualised standard deviation
|
6.6%
|
13.3%
|
18.3%
|
5.1%
|
2011 YTD returns
|
(4.8%)
|
(10.1%)
|
(12.2%)
|
(6.3%)
|
2010 returns
|
8.9%
|
11.6%
|
6.3%
|
4.2%
|
2009 returns
|
20.6%
|
29.1%
|
27.0%
|
7.9%
|
2008 returns
|
(17.7%)
|
(35.8%)
|
(42.9%)
|
(21.1%)
|
Source: Eurekahedge
The Eurekahedge European Hedge Fund Index has gained a substantial 161.43% since its inception in 2000. Since then, European hedge funds have successfully navigated through two downturns, while offering relatively stable returns. Over the last three years, European hedge funds have delivered strong returns in absolute terms and have significantly outperformed when compared to other investment vehicles. The Eurekahedge European Hedge Fund Index ended at -4.8% October 2011 YTD and +8.9% for 2010 which compares favourably to -12.2% and +6.3% for the MSCI Europe Index.
European hedge funds have also finished ahead of the regional funds of hedge funds and long-only absolute return funds. As shown in Figure 8, long-only absolute return funds had an excellent head start at the beginning of 2009 but succumbed to selling pressure in recent months, leaving European hedge funds as the top performers in the market over the last six months. While other European funds could face large sums of withdrawals as the European sovereign debt crisis deepens, European hedge funds are not expected to face the same level of redemption pressure as they have traditionally provided better downturn protection.
Figure 9: Performance of geographical mandates
Table 8: Performance of geographical mandates
|
Europe Investing Funds
|
Global Investing Funds
|
Emerging Markets Investing Funds
|
Eastern Europe and Russia Investing Funds
|
Middle East and Africa Investing Funds
|
6 month returns
|
(5.3%)
|
(5.5%)
|
(10.9%)
|
(17.0%)
|
(1.6%)
|
3 year annualised returns
|
5.8%
|
6.3%
|
9.8%
|
11.1%
|
2.5%
|
3 year annualised standard deviation
|
4.9%
|
4.6%
|
10.9%
|
20.3%
|
7.4%
|
2011 YTD returns
|
(3.8%)
|
(3.5%)
|
(9.3%)
|
(12.0%)
|
1.1%
|
2010 returns
|
7.9%
|
9.2%
|
9.0%
|
16.5%
|
10.2%
|
2009 returns
|
15.1%
|
12.8%
|
35.2%
|
57.8%
|
(2.1%)
|
2008 returns
|
(11.0%)
|
(4.7%)
|
(27.8%)
|
(53.7%)
|
(7.8%)
|
Source: Eurekahedge
In the medium to long term, managers investing in all regions delivered healthy returns despite volatile market conditions in the last three years. In 2011, hedge funds investing in Middle East and Africa delivered a 1.1% return YTD, outperforming their peers who allocated to other geographies. Managers surpassed underlying markets with impressive results as African markets dropped 16.7% YTD and Middle East markets lost 7.6%.
In the three year annualised return measure, managers investing in Eastern Europe and Russia have delivered the best returns due to the strong rallies in the underlying markets in 2009 and 2010. Globally investing European hedge funds registered the lowest annualised volatility of 4.6% in a three year time frame as managers diversified their holdings across numerous markets. This is lower than the annualised volatility of the MSCI World Index of 17.7% as hedge funds lowered their net exposures during volatile markets.
Figure 10: Performance of strategic mandates
Table 9: Performance of strategic mandates
|
Arbitrage
|
CTA / managed futures
|
Event driven
|
Fixed income
|
Long / short equities
|
Macro
|
Multi-strategy
|
Relative value
|
6 month returns
|
(6.3%)
|
3.2%
|
(4.8%)
|
(4.3%)
|
(7.8%)
|
(8.3%)
|
(13.5%)
|
(4.4%)
|
3 year annualised returns
|
1.4%
|
6.3%
|
17.2%
|
12.1%
|
6.3%
|
5.4%
|
2.6%
|
2.8%
|
3 year annualised standard deviation
|
9.2%
|
3.5%
|
9.2%
|
5.0%
|
7.5%
|
7.6%
|
8.4%
|
3.2%
|
2011 YTD returns
|
(4.5%)
|
1.6%
|
(2.7%)
|
(0.7%)
|
(5.8%)
|
(8.0%)
|
(10.3%)
|
(1.4%)
|
2010 returns
|
9.2%
|
10.0%
|
18.3%
|
10.3%
|
8.2%
|
11.1%
|
8.3%
|
7.0%
|
2009 returns
|
14.8%
|
6.6%
|
41.4%
|
26.4%
|
21.7%
|
16.2%
|
14.2%
|
3.8%
|
2008 returns
|
(18.3%)
|
2.0%
|
(15.6%)
|
(15.1%)
|
(18.7%)
|
(36.9%)
|
(21.8%)
|
(7.9%)
|
Source: Eurekahedge
As shown in Table 9, most strategic mandates are in negative territory YTD but have locked in healthy returns in the longer term. Due to the strong performance in 2009 and 2010, the three year total return figure for all strategies is in excess of 8% while event driven European managers led the sector with a three year total return of 60.9%. Event driven managers were able to capitalise on the low valuation opportunities in 2009 and 2010 and delivered excellent returns. European event driven hedge funds also attracted investment flows from investors as they performed exceptionally well in 2009 with a 41.4% return, their best yearly performance on record.
European CTA/managed hedge funds have delivered consistent performance over the years. 2008 was a highly challenging year for hedge funds across most strategies. The notable exception in the European hedge fund investment space has been the CTAs, who were higher by 2.0% by the end of 2008. European CTA hedge funds exhibited returns which were not only positive but also significantly uncorrelated to equity and credit markets. This unique characteristic of CTA hedge funds went on to serve their investors well in 2009 and 2010 as they were up 6.6% and 10.0% respectively in those years. In 2011, CTAs are delivering a repeat performance of 2008 with the average CTA/managed futures fund is up +1.6% while all the other strategic mandates are down for the year.
