Over the last few years no other sector of the global hedge funds industry has witnessed greater change than European hedge funds. The region underwent exponential growth in the five years between 2002 and 2007, reaching a maximum size of US$472.8 billion in October 2007, with the total number of funds crossing the 3000 mark. However the industry saw its asset base reduce drastically during the global financial crisis, losing nearly 40% of assets between January 2008 and March 2009. In this report we analyse the main trends observed over the last five years in European hedge funds and, as a special feature, we explore the growth of UCITSIII hedge funds in the post-financial crisis world.
The growth in European hedge funds since 2000 can be seen in figure 1a, while figure 1b displays the movement in industry assets since April 2009.
Figure 1a: Industry growth of European hedge funds in the past decade
Source: Eurekahedge
The size of the region’s hedge fund industry bottomed out in March 2009, with assets at US$293.6 billion dollars. However the sector has posted a remarkable turnaround since then. Not only have assets recovered on the back of excellent performance and strong asset flows, but an increasing number of launches have brought the total number of funds in the sector to historical highs. Currently the size of the European hedge fund industry stands at US$413.9 billion managed by 3585 funds.
|
Figure 1b – European hedge fund assets
 Source: Eurekahedge |
Asset flows
During the first seven years of the last decade, the European hedge fund industry witnessed excellent growth to reach a maximum size of US$472.8 billion in October 2007. In addition to attracting substantial capital, the region's hedge funds delivered excellent performance-based gains as the Eurekahedge European Hedge Fund Index posted seven years of back-to-back positive returns. During 2008, in the face of heightened volatility across all asset classes leading to losses and massive redemptions in 2H2008 and 1Q2009, industry assets shrank rapidly and fell to US$293.60 billion in March 2009.
As evidenced in Table 1, the monthly asset flows in European hedge funds since January 2009 have seen a trend of redemptions, which turned around in May 2009 as the global economy started to post a recovery. Through exceptional performance based gains over the last two years, as well as some healthy asset flows, the size of the industry is now back above the US$400 billion mark. Additionally, as at April 2011, the sector had witnessed five consecutive months of net positive asset flows – attracting a total of US$30.3 billion dollars during this time.
Table 1: Monthly asset flows in European hedge funds since January 2009
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
|
5.0
|
9.6
|
413.9
|
Source: Eurekahedge
An important aspect of the post financial-crisis European hedge funds industry is the phenomenal growth of the new UCITS III hedge funds[1] - which have not only witnessed strong launch activity but have also attracted most of the assets allocated to European hedge funds. Figure 2a shows the AuMs of non-UCITS III European hedge funds and European UCITS III hedge funds[2]. Figure 2b, which displays the percentage gain/loss in assets, shows that the assets of UCITS III compliant have increased 10 times since January 2006, while assets in non-UCITS European hedge funds have actually declined.
Figure 2a: AuMs of non-UCITS III European hedge funds
and European UCITS III hedge funds since January 2006
and European UCITS III hedge funds since January 2006
Source: Eurekahedge
Figure 2b: Comparative asset flows in non-UCITS III European hedge funds
and European UCITS III hedge funds since January 2006
and European UCITS III hedge funds since January 2006
Source: Eurekahedge
Launches and closures
The European hedge fund population has witnessed some interesting trends in terms of fund launches and closures. 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. Launch activity has 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 130 new funds launched during the first 4 months of the year.
Figure 3: European hedge funds launches and closures since 2005
Source: Eurekahedge
Fees
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. Table 2 shows the average fees of funds launched since 2004.
Table 2: Average fees by launch year
Year
|
Average performance fee (%) of launches
|
Average management fee (%) of launches
|
2004
|
19.41
|
1.59
|
2005
|
19.99
|
1.56
|
2006
|
18.60
|
1.61
|
2007
|
18.32
|
1.64
|
2008
|
17.58
|
1.59
|
2009
|
17.16
|
1.61
|
2010
|
17.89
|
1.65
|
Apr-11
|
17.39
|
1.56
|
Source: Eurekahedge
Fund Sizes
The European sector's excellent performance-based growth, as well as healthy asset flows in the years preceding the financial crisis, has led to proportional changes in the sizes of hedge funds. By mid-2008, 35% of the region's assets were managed by funds with more than US$100 billion. However, widespread redemptions and performance-based losses in end-2008 and early 2009 largely reversed the growth witnessed in the previous five years. Although the proportion of assets in the largest funds, managing US$500 million or more is back to the peak level, the current make-up of the industry still differs significantly from the pre-crisis landscape. The largest difference is the increase in the proportion of assets managed by small hedge funds with US$20 million or less. During the 2008-2009 financial crisis, a number of funds lost their assets either through performance, outflows, or both, hence being ‘demoted' into lower categories. Currently the share of assets in funds with US$100 million or more stands at 28%.
It would be inaccurate to attribute these trends solely to outflows and losses witnessed during the financial crisis. The popularity of UCITS III hedge funds[3] in Europe spawned a large number of start-ups over the last three years, as discussed in previous sections. For these funds, asset-raising has been tough because of the overall market sentiment and predilection among investors to allocate to larger, better-known hedge fund names. Going forward we expect this breakdown to shift in favour of increasing the number of larger funds, in anticipation of better subscription activity in 2011. Hedge fund allocations are predicted to increase in Europe as investors look for investment vehicles that can provide diversification, exposure to growth regions, along with downturn protection.
Figures 4a-4b: A comparative breakdown of European hedge funds by fund size (US$ million)
 |  |
Source: Eurekahedge Source: Eurekahedge
Strategic mandates
The most significant change to the make-up of strategic mandates has been the decrease in the share of assets allocated to long/short equity funds. Although the strategy retains its place as the most popular in Europe, and accounts for a third of the industry’s assets, it has lost 8% of its share between April 2008 and April 2011 as managers employing the strategy suffered rough market conditions during the financial crisis. In addition to losses from falling equity markets, managers also witnessed massive redemptions, bans on short-selling and heightened volatility across the markets – all of which served to further exacerbate their losses. 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 19% of the assets in April 2008 to 25% in April 2011.
Figures 5a-5b: Strategic mandates by assets under management
 |  |
Source: Eurekahedge Source: Eurekahedge
Geographic mandates
European hedge funds investing globally have the largest share of AuM. This is primarily because most European funds invest in North American and Asian markets in addition to Europe, hence employing a global mandate.
The most significant change over the last three years has been the increase in the share of globally mandated years. Reasons for this include better performance of globally mandated funds through the financial crisis and increasing interest from investors looking for diversification, post-financial crisis. Additionally the better performance in 2008-2009 meant a lesser decrease in assets due to performance based losses and also lower redemption pressure vis-Ã -vis European hedge funds investing in other geographies.
Figures 6a-6b: Geographic mandates by assets under management
 |  |
Source: Eurekahedge Source: Eurekahedge
Head office location and domicile
The distribution of head office locations in the European hedge fund industry has not witnessed any significant changes over the last few years. London remains the location of choice for 47% of managers, despite speculation 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 UCITS III platforms. For new managers, London offers a wide range of service providers, administrators 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 38% 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. It should be noted that a UCITS III fund has greater potential to target new, previously untapped capital which gives existing managers significant incentive to either ‘convert’ to the regulatory framework, or to launch a vehicle that is compliant to the framework. This has resulted in the increased share of Ireland and Luxembourg domiciled funds and we expect this trend to continue through 2011.
Figures 7a-7b: Head office location and fund domiciles by number of funds
 |  |
Source: Eurekahedge Source: Eurekahedge
Service Providers
In addition to the changes in the investment mandates, fund sizes and head office locations, the European hedge fund service provider landscape has also witnessed significant changes over the last few years. Increased regulations, greater scrutiny from investors as well as the collapse of two large financial institutions and the subsequent financial crisis, has distinct effects on the approach adopted by European hedge funds towards service providers.
Prime Brokers
Tables 3a-3b indicate the breakdown of market share of European hedge fund assets among major prime brokers. 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 7.53%. 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 which is primarily because of the recognition by hedge fund managers of the counterparty risk posed by prime brokers, which was 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.
Table 3a-3b: Market share of prime brokers by number of funds
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Source: Eurekahedge Source: Eurekahedge
Administrators
The distribution of assets among administrators has also undergone significant changes in the last three years. Tables 4a-4b shows the top 10 administrators by hedge fund assets in 2008 and 2011. Given the emphasis placed on hedge fund managers to have proper third-party administrators, the share of ‘Others’, i.e. the smaller and less well-known administrators, has decreased 33.72% in 2008 to 14.95% in 2011. Additionally, the top five administrators have increased their combined market share and now account for 67.59% of the total European hedge fund assets – up from 49.60% in 2008.
GlobeOp saw the largest increase in market share. The company helped oversee 6.54% of the industry’s assets in 2008 but has since captured 19.83% of the market. According to the company’s interim management statement, GlobeOp’s assets under administration increased 46% increase in the prior 12 months to reach a record high.
Table 4a-4b: Market share of administrators by number of funds
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Source: Eurekahedge Source: Eurekahedge
Performance Review
In this section we analyse the performance of European hedge funds over the last three years, compare the different performance metrics against other asset classes and look at the performance of different investment mandates within the European hedge fund space.
Figure 8: Performance of European hedge funds and other investment vehicles
Source: Eurekahedge
Figure 8 shows the performance of European hedge funds vs. long-only absolute return funds and European equity markets as represented by the MSCI Europe Index. Over the last three years, European hedge funds have not only generated superior returns over long only funds and European equities, but they also displayed the lowest volatility of returns. The Eurekahedge European Hedge Fund Index was up a total of 11.06% between April 2008 and April 2011, outperforming the Eurekahedge Europe Absolute Return Fund Index by 7.94% and the MSCI Europe Index by 21.77%.
In addition to the higher risk adjusted returns, European hedge funds also recorded the lowest drawdown among the three during the financial crisis – losing 20.36% while the MSCI Europe was down 53.61% and the Eurekahedge Absolute Return Index fell 40.86%. Table 5 shows the various performance statistics for the three investment vehicles.
Table 5: Performance of European hedge funds and other investment vehicles
Eurekahedge European Hedge Fund Index
|
Eurekahedge Europe Absolute Return
Fund Index |
MSCI
Europe | |
12 month return
|
7.05%
|
9.42%
|
9.00%
|
3 year annualised return
|
3.56%
|
1.03%
|
-3.71%
|
3 year annualised standard deviation
|
8.41%
|
14.87%
|
21.69%
|
2011 YTD return
|
2.24%
|
3.06%
|
4.43%
|
2010 return
|
9.02%
|
10.18%
|
6.28%
|
2009 return
|
20.15%
|
25.92%
|
27.03%
|
Source: Eurekahedge
Geographical Mandates Performance
The performance of the European hedge funds across the different geographical mandates, as displayed in figure 9, shows a distinct difference across the spectrum. Funds investing in Eastern Europe and Russia have witnessed the largest gains in 2010 and 2011 YTD, supported by the strong rebound in the underlying markets in the post financial-crisis period. Additionally in 2009, European hedge funds investing in Eastern Europe delivered the strongest annual return, 57.52% while the MSCI Eastern Europe Index was up 67.3%. However, the 3 year annualised return of these funds remains in the red, as they also suffered the largest losses in 2008 and have the highest volatility of returns among the different mandates – as shown in table 6.
Figure 9: Performance of geographic mandates
Source: Eurekahedge
European hedge funds investing with a global mandate have delivered the highest annualised returns over the last three years, with the lowest volatility. Managers investing with broader mandates generally tend to outperform in times of high volatility and provide downturn protection. This has been one of the main reasons why investors have preferred to allocate greater capital to global-investing funds over funds focused on one particular region or country.
Table 6: Performance of geographic mandates
Europe Investing Funds
|
Global Investing Funds
|
Emerging Markets Investing Funds
|
Eastern Europe and Russia Investing Funds
|
Middle East and Africa Investing Funds
| |
12 month return
|
6.23%
|
8.34%
|
7.69%
|
11.33%
|
7.93%
|
3 year annualised return
|
4.06%
|
5.64%
|
4.37%
|
-2.83%
|
-2.20%
|
3 year annualised standard deviation
|
5.85%
|
5.36%
|
12.73%
|
25.70%
|
8.97%
|
2011 YTD return
|
1.65%
|
2.13%
|
1.76%
|
5.98%
|
2.01%
|
2010 return
|
7.81%
|
9.50%
|
9.07%
|
17.59%
|
10.21%
|
2009 return
|
14.80%
|
12.64%
|
35.37%
|
57.52%
|
-5.56%
|
Source: Eurekahedge
Strategic Mandates Performance
All strategies delivered positive performance in 2010 and the first four months of 2011 as shown in figure 10. Event driven funds have been the best performers over the last 3 years and also led the way in 2010. Event driven hedge funds posted excellent gains in 2009 and 2010 as managers amid resurgent corporate activity. In 2010 the total value of M&A deals in Europe was US$629.8 billion, up 37% from $459.6B in 2009[4]. Another report by E&Y said that IPOs on European exchanges in 2010 raised US$36.7 billion, the highest volume since 2007.
Figure 10: Performance across strategic mandates
Source: Eurekahedge
CTA/managed futures funds witnessed the lowest volatility of returns, with a 3 year annualised standard deviation of 4.72%. CTA managers delivered exceptional downturn protection in 2008, gaining 1.17% at a time when the average European hedge fund was down 18.23%. Although the yearly returns are comparatively conservative, the consistency offered by CTA/managed futures funds culminates into substantial risk-adjusted performance over the longer term.
Table 7: Performance across strategic mandates
Arbitrage
|
CTA / Managed Futures
|
Distressed Debt
|
Event Driven
|
Fixed Income
|
Long / Short Equities
|
Macro
|
Multi-Strategy
|
Relative Value
| |
12 month return
|
6.52%
|
9.78%
|
5.88%
|
11.88%
|
7.27%
|
6.28%
|
7.47%
|
9.83%
|
7.40%
|
3 year annualised return
|
1.70%
|
5.73%
|
3.24%
|
9.55%
|
7.93%
|
3.19%
|
-7.48%
|
0.49%
|
0.67%
|
3 year annualised standard deviation
|
9.44%
|
4.72%
|
15.60%
|
9.76%
|
8.41%
|
8.68%
|
23.35%
|
11.41%
|
5.06%
|
2011 YTD return
|
2.10%
|
1.58%
|
7.07%
|
1.33%
|
4.07%
|
2.04%
|
0.52%
|
3.24%
|
1.03%
|
2010 return
|
8.48%
|
9.93%
|
8.73%
|
18.96%
|
10.67%
|
8.17%
|
15.99%
|
9.41%
|
7.49%
|
2009 return
|
14.74%
|
6.15%
|
33.61%
|
28.89%
|
26.75%
|
21.19%
|
23.78%
|
17.37%
|
0.22%
|
Source: Eurekahedge
The scatter plot in figure 11 shows the distribution of reward versus risk of all European hedge funds over a 36 month period. The key takeaways from this chart are:
a) Most of the funds with high standard deviations have low, or negative rates of returns, while hedge funds with low volatilities have better performance on average
b) More than half of the European hedge funds (median) have net positive returns after 3 years, outperforming the MSCI Europe Index.
c) The best performing fund, achieved annualised returns of more than 150% per year although more than 40% annual volatility.
Figure 11: 3 year risk-return scatter plot of European hedge funds
Source: Eurekahedge
The histograms shown in figures 12a and 12b give the distribution of annualised returns and annualised standard deviation of European hedge funds. Half of the funds had an annualised 3 year return of more than 4.4%, and volatility of less than 10.4%. Comparatively, the MSCI AC Europe Index delivered a 3 year annual return of -3.6% and 20.4% standard deviation, underperforming the majority of hedge funds.
Figure 12a-12b: Histogram of 3 year performance statistics
 |  |
Source: Eurekahedge Source: Eurekahedge
[1] UCITS is an acronym for “Undertakings for Collective Investment in Transferable Securities”, an EU collective investment regulation. For more information on UCITS hedge funds, please read the ‘Eurekahedge Key Trends in UCITS Hedge Funds’ feature published in the April 2011 edition of The
Eurekahedge Report.
[2] This excludes some funds that subscribe to the UCITS III regulation, but are neither located nor investing in Europe
[3] For more details on the development of UCITS III hedge funds, please refer to the ‘Eurekahedge Key Trends in UCITS Hedge Funds’ feature
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