Introduction
North American hedge funds witnessed another year of strong growth in 2011, despite a flat to slightly negative performance amid unhelpful market conditions. The Eurekahedge North American Hedge Fund Index registered a -1.13% return for the year, however the industry attracted US$60.9 billion in net positive asset flows from investors.
Since the turn of the millennium, North American hedge funds have witnessed some significant trends. At the start of 2000 the industry held US$258 billion in assets managed by 1,815 managers. Over the next eight and a half years, the sector grew exponentially with assets under management (AuM) peaking in June 2008 at US$1,247 billion – an increase of nearly 500%. The fund population also increased significantly to cross 4,600 funds over the same period. The industry saw its asset base reduce drastically during the global financial crisis, losing nearly 32% of assets between June 2008 and April 2009. Additionally, a large number of hedge funds closed down during this time and the number of funds fell to 4,453 funds by end-June 2009.
Figure 1: Industry growth since 2000
The size of the region’s hedge fund industry bottomed out in April 2009, with assets falling below US$850 billion. The subsequent turnaround in global markets and return of investor confidence set the stage for a remarkable recovery in the North American hedge funds sector. Managers posted excellent performance-based growth in the last three quarters of 2009 and in 2010, while also attracting significant asset flows. Although performance was flat in 2011 the trend of healthy inflows continued through the year, as discussed in the next section.
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Asset flows
North American managers witnessed a remarkable period of continued positive asset flows in 2010 and 2011. In the 19 months from February 2010 to August 2011 the sector gained nearly US$150 billion through strong allocation activity.
Table 1: Monthly asset flows in North American hedge funds since January 2009
Month
|
Net growth (performance)
|
Net flows
|
Assets at end
|
Jan-09
|
6.7
|
(63.2)
|
918.6
|
Feb-09
|
(3.1)
|
(12.6)
|
902.8
|
Mar-09
|
(1.2)
|
(25.6)
|
876.1
|
Apr-09
|
7.5
|
(34.4)
|
849.2
|
May-09
|
22.6
|
1.1
|
872.9
|
Jun-09
|
(0.0)
|
7.2
|
880.1
|
Jul-09
|
13.4
|
(0.4)
|
893.1
|
Aug-09
|
7.9
|
10.9
|
911.9
|
Sep-09
|
16.7
|
13.3
|
941.9
|
Oct-09
|
0.5
|
5.1
|
947.5
|
Nov-09
|
11.1
|
4.5
|
963.1
|
Dec-09
|
6.4
|
(6.6)
|
962.9
|
2009
|
88.5
|
-100.7
|
962.9
|
Jan-10
|
(1.3)
|
(2.6)
|
959.0
|
Feb-10
|
3.2
|
17.5
|
979.6
|
Mar-10
|
16.2
|
0.3
|
996.2
|
Apr-10
|
10.1
|
1.5
|
1007.8
|
May-10
|
(18.2)
|
6.5
|
996.1
|
Jun-10
|
(1.5)
|
1.3
|
995.9
|
Jul-10
|
8.4
|
1.7
|
1006.0
|
Aug-10
|
7.5
|
15.0
|
1028.5
|
Sep-10
|
22.9
|
4.9
|
1056.3
|
Oct-10
|
19.1
|
6.6
|
1082.0
|
Nov-10
|
(2.8)
|
3.5
|
1082.7
|
Dec-10
|
26.2
|
1.4
|
1110.2
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2010
|
89.8
|
57.6
|
1110.2
|
Jan-11
|
2.1
|
11.9
|
1124.2
|
Feb-11
|
13.3
|
14.1
|
1151.6
|
Mar-11
|
(0.3)
|
15.8
|
1167.1
|
Apr-11
|
19.3
|
25.7
|
1212.2
|
May-11
|
(9.7)
|
8.0
|
1210.5
|
Jun-11
|
(12.7)
|
5.6
|
1203.4
|
Jul-11
|
8.9
|
2.3
|
1214.5
|
Aug-11
|
(8.8)
|
3.2
|
1208.8
|
Sep-11
|
(19.1)
|
(15.0)
|
1174.8
|
Oct-11
|
4.2
|
(1.6)
|
1177.4
|
Nov-11
|
(0.8)
|
(7.5)
|
1169.2
|
Dec-11
|
0.7
|
(1.6)
|
1168.3
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2011
|
(2.8)
|
60.9
|
1168.3
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Source: Eurekahedge
Strong allocation activity seen in 2010 and the first eight months of 2011 was not only a result of excellent performance in 2009 and 2010, and the significant downturn protection in 2008 but also due to various measures undertaken by managers to placate investor concerns. These include addressing issues such as counter-party risk by diversifying their prime broker relationships, engaging reputable third-party administrators, increased transparency and redemption frequency. These measures had the effect of rebuilding investor confidence in the hedge fund industry, which resulted in significant asset flows.
Regional managers witnessed net negative flows in the last four months of 2011 as investor sentiment declined due to increasing concerns about European debt situation and heightened volatility in global markets. Despite the challenges at the end of the year, total allocations to North American hedge funds in 2011 stood at a strong US$60.9 billion – the highest yearly net flow since 2007.
Currently, the size of the North American hedge fund industry stands at US$1168.3 billion and over the next 12 months we expect the managers to attract more capital. Direct investments into hedge funds, as opposed to going through funds of hedge funds, have become more popular among institutional investors since 2008, and this trend is set to continue in 2012 especially since the number of hedge fund launches by pedigreed proprietary traders is expected to increase during the year.
Launches and closures
In addition to strong asset flows, the North American hedge fund sector also witnessed healthy population growth in 2011 with the total number of new launches exceeding 460 funds. The increasing number of hedge fund launches over the last year has been driven not only by the increasing appetite of institutional investors for alternative investments but also because a large number of proprietary traders are leaving banks to set up their own hedge funds - due in no small part to regulatory reform (Volcker Rule). Although the number of launches decreased over the last two quarters of 2011, strong launch activity is anticipated in 2012.
Figure 2: Launches and closures of North American hedge funds since 1Q 2008
Fees
In order to attract greater capital from investors, hedge funds started to alter their fee structures in the wake of the financial crisis, as shown in table 2. Managers came under criticism from investors and regulators for their fee structures and moved to address these concerns by lowering their performance fees. Historically the average performance fees of hedge funds have remained above 19% and crossed 20% in 2007. In 2009 the average fees charged by new hedge fund launches was 17.45%, and since then they have remained below 19%.
Table 2: Changes in fee structures of hedge fund launches between 2004 and 2011
Year
|
Average performance fees of launches (%)
|
Average management fees of launches (%)
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2004
|
19.60
|
1.57
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2005
|
19.92
|
1.69
|
2006
|
19.47
|
1.66
|
2007
|
20.35
|
1.63
|
2008
|
19.14
|
1.57
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2009
|
17.45
|
1.67
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2010
|
18.85
|
1.68
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2011
|
18.92
|
1.80
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Source: Eurekahedge
Head office location
Figure 3 gives a snapshot of head office locations in North American hedge funds. The United States accounts for 81% of the North American hedge fund population, followed by the United Kingdom at 9%. Setting up an office in the US gives managers ready access to the largest pool of hedge fund investors. Additionally, North America remained the most developed hedge fund market with the greatest number of financial products, service providers and financially trained talent. It should be noted that the share of the US had dropped to 77% in 2009 amid a high attrition rate; strong launch activity in 2010 has brought it back up above 80%.
Figure 3: Head office location by number of funds
Fund sizes
The North American hedge fund industry witnessed some significant changes over the last few years in terms of distribution by fund sizes. By December 2007, before the onset of the financial crisis, the proportion of smaller hedge funds managing US$50 million or less had fallen to 55%. Between December 2007 and December 2009 this number increased to account for 61% of the industry as managers suffered significant losses through the financial crisis and panicked investors withdrew large sums of capital. Since then this number has fallen to 57% as regional managers posted excellent performance-based growth as well as attracting capital. Most of the capital allocated to North American hedge funds has mostly gone to the larger funds as investors prefer allocating to established brand names with proven track records of being able to manage a large asset base. Furthermore, allocations to large hedge funds are associated with greater liquidity since one investor’s capital will not form a large part of total fund AuM, and hence can be redeemed with greater ease.
Figures 4a-4c: Changes in the composition of the fund population by fund since December 2007
Geographic mandates
The three leading mandates that the regional hedge funds focus on are global, North America and emerging markets, and as of December 2011, 63% of North American hedge funds invest globally; an increase of 9% since December 2007.
Reasons for this include increasing interest from investors looking for diversification, post-financial crisis. The better performance in 2008 of globally focused funds also played a part, as this meant a smaller decrease in assets due to performance-based losses and lower redemption pressure vis-à-vis North America focused funds. Other benefits of investing globally include the ability of funds to diversify their holdings across many countries, which is helpful for portfolio volatility reduction. Although it seems that very little capital is allocated to emerging markets and Asia, in reality most North American investors gain exposure to these markets by employing a global mandate.
An additional reason for the increase in the number of globally focused hedge funds is the growing importance of commodities and other investments over the last few years. Higher commodity prices have attracted greater interest from hedge funds, and since such investments tend to be global in nature, a number of North American hedge funds have switched their focus from being North America-specific to adopting a more flexible investment style.
Figures 5a-5c: Geographic mandates by AuM since 2007
Strategic mandates
The North American hedge fund sector has witnessed some interesting trends in terms of strategic mandates. While long/short equity remains the most popular hedge fund strategy in the region, its share of hedge fund assets has decreased from 37% to 30% over the last four years. Reasons for this trend include the increasing availability and popularity of other hedge fund strategies, flight of capital to ‘safer’ asset classes during the credit crunch and the financial crisis, as well as heavy redemptions and losses suffered by North American long/short equity managers during the financial crisis.
Strategies that have increased their share of hedge fund assets include CTA/managed futures funds and macro investing funds. While most other strategies finished the year with negative returns, these strategies delivered positive performance in 2008, resulting in a proportional increase in their share of North American hedge fund assets. Due to this performance CTA and macro managers also received significant capital from investors in subsequent years, further adding to their gains. Event driven hedge funds have also increased their share from 8% of the industry assets to 12% over the last four years. This increase has been driven by their excellent performance in 2009 and 2010 as well as sustained allocation by investors in 2010 and 2011.
Figures 6a-6c: Strategic mandates by AuM since December 2007
Administrators
The distribution of assets among administrators has also undergone significant changes in the last three years. Tables 3a and 3b show the top 10 administrators by hedge fund assets in 2008 and 2011. Given the heightened stress placed on hedge funds to provide greater transparency in the wake of the financial crisis, managers have affected several changes to address investor concerns. These changes include employing proper third-party administrators, which has also become a key due diligence criteria for investors. The combined share of the top 10 administrations has increased from 59.9% in 2008 to 63.9%.
Tables 3a-3b: Market share of administrators by assets under administration
December 2008
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Administrator
|
Market share
|
CITCO
|
16.1%
|
HSBC
|
8.5%
|
Citigroup
|
8.4%
|
Bank of New York
|
8.2%
|
State Street
|
5.5%
|
Custom House
|
3.4%
|
Fortis
|
3.1%
|
Goldman Sachs
|
2.7%
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IFA
|
2.2%
|
SEI Investment Services
|
1.9%
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Others
|
40.1%
|
|
December 2011
|
Administrator
|
Market share
|
CITCO
|
16.4%
|
State Street
|
10.5%
|
Custom House
|
8.4%
|
Citigroup
|
6.3%
|
HSBC
|
6.3%
|
Bank of New York
|
4.9%
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GlobeOp
|
2.8%
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Goldman Sachs
|
2.8%
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SEI Investment Services
|
2.8%
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SS&C
|
2.6%
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Others
|
36.1%
|
|
Source: Eurekahedge Source: Eurekahedge
Prime brokers
The breakdown of the prime brokers’ share of North American hedge fund assets has also seen some changes through the financial crisis. Tables 4a and 4b show the share of prime brokers in 2008 and 2011 based on data reported to the Eurekahedge databases by hedge funds themselves and not by prime brokers. While the top three prime brokers have remained the same, there is now more equitable distribution across the other top-ten players. This is primarily because of hedge funds choosing to use more than one prime broker as a measure against counter-party risk. The share of ‘Others’ has also decreased to less than 10% as the industry has grown towards consolidation by larger financial institutions.
Tables 4a-4b: Market share of prime brokers by AuM
December 2008
|
Prime broker
|
Market share
|
J.P. Morgan
|
24.74%
|
Goldman Sachs
|
17.33%
|
Morgan Stanley
|
14.75%
|
Barclays Capital
|
7.53%
|
UBS
|
5.28%
|
Citigroup
|
4.71%
|
Deutsche Bank
|
3.75%
|
BNP Paribas
|
3.75%
|
Merrill Lynch
|
2.93%
|
HSBC
|
2.47%
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Others
|
12.77%
|
|
December 2011
|
Prime broker
|
Market share
|
JP Morgan
|
21.77%
|
Goldman Sachs
|
15.27%
|
Morgan Stanley
|
13.17%
|
Credit Suisse
|
10.78%
|
Deutsche Bank
|
10.60%
|
Citibank
|
5.63%
|
UBS
|
4.44%
|
Bank of America Merrill Lynch
|
3.39%
|
Barclays
|
3.33%
|
Newedge
|
2.47%
|
Others
|
9.2%
|
|
Source: Eurekahedge Source: Eurekahedge
Performance review
Figure 7: Performance of North American hedge funds vs. other investment vehicles since December 1999
As shown in figure 7, North American hedge funds have delivered the best performance, followed by North American long only absolute return funds. The Eurekahedge North American Hedge Fund Index gained 225.5% since 2000 as managers navigated their way through two financial crises. It was during the downturns that hedge funds outperformed underlying markets by wider margins. In 2008, the S&P lost a massive 38.49% of its value but North American hedge funds finished the year lower by 9.49%. Similarly in 2002, hedge funds gained 3.01% while the S&P 500 lost 23.37% by year-end.
Figure 8: Rolling 12 month annualised volatility of North American hedge funds
As shown in figure 8, North American alternative investments achieved a lower standard deviation compared to the traditional long only investments. Except for a brief period in 2009, the annualised volatility of funds of hedge funds and hedge funds never exceeded 10%. This stands in stark contrast to the standard deviations of the S&P 500 and long only absolute return funds, which reached as high as 30% and 25% respectively during the financial market fallout in early 2009. Another obvious observation from the chart is that product derivatives – namely the long only funds and funds of hedge funds, follow the trend of volatility of their underlying investments (represented by the S&P 500 and Eurekahedge Hedge Fund Index) but their standard deviations are comparatively lower. This is a result of diversification which has mitigated the idiosyncratic risk of the individual assets and lowered the overall volatility of the portfolio.
Table 5: Performance of North American hedge funds vs. other investment vehicles
|
EH North American Hedge Fund Index
|
EH North America Fund of Funds Index
|
EH North America Absolute Return Fund Index
|
S&P
500
|
6 month returns
|
-3.73%
|
-4.00%
|
-9.93%
|
-4.77%
|
2011 YTD returns
|
-1.12%
|
-2.25%
|
-7.26%
|
0.00%
|
3 year annualised returns
|
11.92%
|
6.22%
|
13.91%
|
11.66%
|
3 year annualised standard deviation
|
6.66%
|
4.68%
|
16.03%
|
19.00%
|
Sharpe Ratio (RFR = 2%)
|
1.49
|
0.90
|
0.74
|
0.51
|
Source: Eurekahedge
Table 5 demonstrates the performance of North American hedge funds but unlike figure 7, examines the numbers over a shorter term. North American hedge funds continued their winning streak against long only and North America funds of hedge funds but fell short of the S&P 500 Index return in 2011. It was a challenging year for discretionary managers as demonstrated by the performance of long only managers who ended the year 7.26% into negative territory. Market conditions made it difficult for value or bottom-up managers to invest. Added to this, securities became so mispriced that fundamentals no longer mattered as regulators intervened in the markets frequently through the year, creating an uncertain and hard environment for traders and asset managers.
Figure 9: Performance of geographic mandates
Table 6: Performance of geographic mandates
|
EH Global Investing North American Hedge Fund Index
|
EH North American Investing Hedge Fund Index
|
6 month returns
|
-4.03%
|
-3.75%
|
2011 YTD returns
|
-4.82%
|
-1.18%
|
3 year annualised returns
|
6.95%
|
11.87%
|
3 year annualised standard deviation
|
5.78%
|
6.69%
|
Sharpe Ratio (RFR = 2%)
|
0.86
|
1.48
|
Source: Eurekahedge
In the past three years North American focused mandates have performed better than global investing mandates on almost all fronts. According to Eurekahedge benchmarks, North American investing hedge funds have returned 40% while global investment mandates were up 22.34% from December 2008 to December 2011. Both investment mandates have delivered consistent risk adjusted results over the last three years, the 3 year Sharpe ratio of North America focused funds is 1.48 and while that of globally investing funds is 0.86. in 2011, the performance of the globally investing funds edged lower versus North American investments, primarily due to uncertain underlying market conditions which were triggered by a number of unprecedented events - including the devastating earthquake in Japan, political instability in the Middle East and the continuing sovereign debt issues in Europe. Despite these tough market conditions, North American investing funds are close to a flat performance for 2011.
Figure 10: Performance across strategic mandates
Table 7: Performance across strategic mandates
|
Arbitrage
|
CTA / managed futures
|
Distressed Debt
|
Event Driven
|
Fixed Income
|
Long / Short Equities
|
Multi-Strategy
|
Relative Value
|
6 month returns
|
-0.12%
|
2.48%
|
-9.78%
|
-2.76%
|
0.27%
|
-7.71%
|
-4.25%
|
-4.93%
|
2011 YTD Returns
|
3.18%
|
2.46%
|
-5.14%
|
-0.62%
|
6.02%
|
-4.92%
|
-1.37%
|
-1.10%
|
3 year annualised returns
|
13.88%
|
8.00%
|
21.31%
|
20.97%
|
17.10%
|
10.33%
|
10.33%
|
14.73%
|
3 year annualised standard deviation
|
4.39%
|
6.18%
|
13.15%
|
11.35%
|
3.61%
|
9.29%
|
5.77%
|
8.18%
|
Sharpe Ratio (RFR = 2%)
|
2.71
|
0.97
|
1.47
|
1.67
|
4.18
|
0.90
|
1.44
|
1.56
|
Source: Eurekahedge
Although the performance across most North American strategic mandates (see table 7) was weaker than expected, the three year return figures still remain strong. Event driven strategies turned out to be the second most profitable over the three year term as managers reaped a cumulative return of 77.04%. This happened against a backdrop of strong corporate activity in North American markets and robust inflows from investors. During this period the assets under management in event driven funds increased 13.2%, amounting to US$16 billion. 2010 was a great year for event driven mandates as North America became the top destination for merger and acquisitions with 9,676 deals announced during the year. The Eurekahedge North America Event Driven Hedge Fund Index finished 2010 18.75% higher but the preceding year 2009 was even more impressive - the index achieved its highest yearly return on record as North American event driven hedge funds surged a massive 50.02%.
North American distressed debt hedge funds ostensibly performed well in a low interest rate environment even when financing was hard to come by. The Eurekahedge North America Distressed Debt Hedge Fund Index gained 78.53% by the end of the period. Similar to event driven funds, most of the gains were made in 2009 when the index witnessed its highest ever annual return of 46.12%. Managers were in negative territory in 2011 as the European debt crisis affected investment sentiment on distressed issues in the US. Further negativity could be found in the first 11 months of 2011, 39 new US municipal bond deals entered monetary default, totalling over US$800 million in par value.
