Introduction
Over the last decade, the global hedge fund industry has undergone exponential growth both in terms of assets under management and number of funds. Hedge fund assets hit their peak in June 2008 at US$1.95 trillion – a seven-fold increase since end-1999 – before declining due to drying-up liquidity, the collapse of some large financial institutions, tumbling equity markets and the resultant spike in risk aversion, which led to widespread redemptions. However, hedge funds turned the corner after March 2009, posting excellent returns as well as attracting capital from April through December 2009 as the global financial markets posted a recovery.
Figure 1 below shows the growth in the number of funds and the assets over the past decade.
Figure 1: Growth of the Global Hedge Fund Industry
The start of 2009 saw the global hedge fund sector in the middle of its greatest downturn, with managers facing extraordinary redemption pressures as well as performance-based declines. The heavy withdrawals from hedge funds further translated into greater losses for managers as they were forced to liquidate potentially lucrative positions to meet redemption demands.
However, after hitting a low US$1.29 trillion in April 2009, hedge funds reverted to the growth trend by posting strong performances and gaining significant capital inflows towards the end of 2009 at US$1.48 trillion – an increase of almost 15% in the last eight months of the year.
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Industry Make-Up and Growth Trends
Asset Flows
Table 1: Asset Flows across Global Hedge Funds
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Table 1 shows the monthly breakdown of asset flows in global hedge funds over the last two years, which have been quite tumultuous for the sector. Coming out of 2007 after a period of strong inflows and performances, the industry reached its zenith in June 2008 with US$1.95 trillion in assets under management before the combined effect of withdrawals and performance-based losses led to a significant decline in total assets. As mentioned above, the assets under management fell to US$1.29 trillion by April 2009, shrinking by nearly 30% before posting a recovery.
Coming on the back of a 13% decline in assets due to negative net flows in 4Q2008, redemptions in 1Q2009 were lower in both absolute and percentage terms – US$158.4 billion and 10.8%, respectively. Additionally, we believe that most of the redemptions seen in 1Q2009 were largely due to two main reasons:
a) A large number of hedge funds that had suspended redemptions towards the end of 2008 in order to minimise losses from forced liquidations re-allowed investors to withdraw their capital in January.
b) The Madoff scandal in December 2008 triggered heavy outflows from funds of hedge funds, which had been exposed to the fraudulent scheme, thereby resulting in a spate of outflows from the underlying single-manager industry.
Despite these two major factors, Table 1 shows a distinct slowdown in the shrinkage of industry assets in 1Q2009 as investors took into consideration the industry’s outperformance over the underlying markets as well as signs of stability across the global economy. The second quarter saw the trend of redemptions reversing as the industry started growing once again and the sector witnessed strong net positive asset flows through the rest of the year which are attributed to the following reasons:
a) As the global markets posted a recovery post-March 2009, investors who had redeemed their capital were keen on getting their money back into the system.
b) Hedge funds significantly outperformed the underlying markets in 2008, losing on average 11% as opposed to the 40-60% losses in the markets, and investors took this downturn protection into consideration when allocating their capital in 2009.
c) Increased risk appetite due to the recovery in the markets led to further allocations to the sector.
d) Hedge funds have traditionally provided greater risk-adjusted returns over the longer term, hence attracting investors who were looking for stable returns – the Eurekahedge Hedge Fund Index is up 37.7% while the MSCI World Index is down 7.1% since the start of 2006.
e) Another effect of the financial crisis was that investors increasingly started to diversify their portfolios and the hedge fund industry offered an attractive alternative to mutual funds and other traditional investment vehicles.
f) Those investors who had previously allocated to funds of hedge funds and hence suffered losses in 2008 started moving towards directly investing in single-manager funds.
g) Regulations that are currently being touted and imposed by fiduciary bodies after the Madoff scandal served to attract large institutional investors and pension funds that previously allocated only a small portion of their portfolios to hedge funds (or refrained completely from investing in them) due to lack of transparency and high-perceived risk.
h) A significant number of hedge fund managers also reduced their performance fees in response to investor demand.
Figure 2: Asset Flows across Hedge Funds and Funds of Funds
Figure 2 shows the change in assets under management for the hedge fund and fund of funds industries over the last two years. Although hedge fund assets under management started growing after March 2009, funds of funds continued to see net redemptions through the rest of the year as investors remained cautious about the multi-manager model after largely negative returns in 2008 and some high-profile scams such as the Madoff Ponzi scheme. With concerns over the exposure to fraudulent hedge funds, institutional and private investors are now demanding more transparency and communications from asset managers and are also directly investing in single-manager hedge funds as opposed to going through multi-managers.
An interesting trend observed in Table 1 is the strong correlation between a month’s negative performance and net redemptions in the following one or two months and this is equally true for net inflows following months of strong positive performance returns. Figure 3 further demonstrates this observation.
Figure 3: Displaced Moving Average Net Flows vs EH Global Hedge Fund Index
Figure 3 displays the correlation between asset flows and performance – the blue line tracks the three-month moving average of net flows (from Table 1) displaced by two months while the red line shows the Eurekahedge Hedge Fund Index. 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. 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.
Whether this truly suggests that investors are ‘trend-following’ or a simple statistical manipulation is open to some debate.
Launches and Liquidations
The ebb and flow of assets in the industry has also been accompanied by an increase and decrease in the number of hedge funds. Over the years, the global hedge fund population has witnessed tremendous growth; starting from about 2,200 funds globally in January 2000, the number of funds currently stands at just under 8,400 funds – increasing almost three-fold over the ten-year period.
The last two years, however, saw an increase in the rate of closures, as shown in Figure 4.
Figure 4: Launches and Liquidations across the Global Hedge Fund Industry
The last two years also saw a spike in attrition in the hedge fund space, going against the trend of launches, outnumbering closures. The fourth quarter of 2008 was the worst on record for hedge funds in terms of closures as the year itself saw more than 900 funds shutting shop. The trend continued well in 2009 as managers were faced with widespread redemptions and large losses due to the market downturn, which rendered them unable to charge performance fees, hence leading to an inability to meet operating expenses. However, with performance picking up in 2009, a number of managers started meeting their high-water marks and with net outflows also slowing down, the rate of closures decreased by the end of 1H2009.
The second half of 2009 witnessed fund launches and closures evening out as the industry saw a healthy number of hedge fund start-ups by managers aiming to exploit the attractive valuations and other opportunities available in the markets. Going forward, we expect the fund population to revert back to historical levels of healthy growth in 2010 as the global markets stabilise and investors continue to seek out the consistent risk-adjusted performance delivered by hedge funds.
Fund Sizes
Figures 5a-5c: Breakdown of Hedge Funds by Fund Sizes
The global hedge fund industry has gone through some noticeable changes over the last few years in terms of fund sizes. The share of large hedge funds, managing over US$1 billion in assets, increased from 1% to 3% from 2004 to mid-2008 as the industry went through rapid growth. The growth in this period is visible across all hedge fund size ‘tranches’ – most notable among these is the decrease in the share of funds below US$50 million from 59% to 53%. Given that the total number of hedge funds increased by 15% during this time and a great number of funds started small, this decrease in the percentage share of the smaller funds is quite remarkable as it means that an increasing number of the smaller funds grew rapidly to ‘jump’ into the higher assets under management bands.
However, a significant portion of this growth was reversed between the period of June 2008 and December 2009 due to large scale redemptions triggered by a dearth of liquidity in the markets, panic among investors and recessionary pressures. Hedge funds across all the larger size categories decreased in number while the share of funds below US$50 million burgeoned to more than 61% of the universe as a good portion of funds in the US$50-200 million bracket shrank notably in size due to losses and redemptions. Additionally, this increase was bolstered by a number of small hedge fund start-ups in 2009 as new managers found it hard to raise capital during the financial downturn. In fact, the number of hedge fund start-ups is expected to increase in the future as many perceive the current economic conditions as an opportune time to start a hedge fund due to the following reasons:
a) Firstly, asset prices in some sectors are still quite a way off their previous highs.
b) Secondly, there are many talented managers who plan to leave their positions at financial institutions because of increased banking regulation and bureaucratic constraints giving hedge funds better employment bargaining power.
c) And lastly, central banks are still in quantitative easing modes, which means that financial markets would remain more liquid.
Geographical Mandates
Figures 6a-6c: Changes in the Geographic Mix of Global Hedge Funds
Assets managed by North American managers increased to US$962 billion at the end of 2009 from US$803 billion in 2004, representing 19.8% gains and maintaining the region as the primary market for hedge funds. The total market cap of all exchanges in North America stood at US$16.6 trillion at the end-2009 and it is regarded as one of the most liquid markets in the world, hence creating an abundance of opportunities for hedge fund managers. However, the drop in the North American market share from 70% to 65% highlights the increasing diversity in hedge fund asset allocations and managers’ quest to gain exposure to growth markets, especially those in Asia ex-Japan[1] and Latin America[2]. Allocations to these regions, as opposed to developed markets, have been justified over the short term as well as in the longer time frame – Eurekahedge Emerging Markets Hedge Fund Index gained 92% in the last five years and the Eurekahedge Asia ex-Japan Hedge Fund Index delivered a record 37.49% in 2009 alone. These performances have served to attract greater capital to these regions, especially in 2009 as emerging markets are widely expected to post a faster recovery going forward. Furthermore, with the recent uncertainty and turbulence in the underlying markets and economy, investors have preferred investing in global-mandated funds in order to diversify their investments geographically and hence minimise their risks.
Japan is the other developed region that lost market share in terms of hedge fund geographic mandates, going from 2% to 1%. This is mainly because Japanese hedge funds have underperformed their regional peers since the end of the bull market in 2005 and the assets under management held by Japanese hedge fund managers have also declined by 40% from 2004 to 2009 as investors chose to shift their assets to other better performing markets in the region.
Strategic Mandates
Figures 7a-7c : Changes in the Strategic Mix of Global Hedge Funds by Assets under Management
The last five years have also seen a few noteworthy changes in the strategic mandate distribution among global hedge funds. Long/short equity managers lost 6% of their share because of aggressive sell-off in the underlying markets and the volatile performance of long/short funds in 2008 and early-2009. Investors diversified their capital away from long/short equity funds and into other strategies such as multi-strategy and event driven hedge funds, which increased by 4% and 6%, respectively, during the five-year period.
On an absolute basis, event driven hedge funds saw the largest increase in assets under management by posting a 147% increase from December 2004 to December 2009. The number of opportunities for event driven managers has increased in the last two years as financial markets recovered from the crisis. Equity-focused event driven managers were able to capture gains from the increasing number of company acquisitions as well as spin-offs in 2009 due to the attractive valuations available in the market while event driven hedge fund managers focused on trading fixed income locked in gains from the increased number of debt refinancing and restructuring events in 2009. Furthermore, event driven funds tend to perform well in the early stage of a cyclical recovery, for example, event driven hedge funds stood as the second-best performing strategy in the last financial recovery in 2004 – the Eurekahedge Event Driven Hedge Fund Index was up a massive 38.63%.
Head Office Location
Most global hedge funds continue to be based in the UK and the US, with the latter still accounting for nearly half of the hedge funds in the world, being the oldest hedge fund centre (where the world’s first hedge fund was set up in 1949) and providing managers with a large investor base to raise capital from a diverse set of hedge fund service providers to partner with. However, the percentage of funds based in these locations has fallen from 71% in December 2004 to 66% in 2009 as increasing number of managers have started setting up offices in Asia and other locations.
Furthermore, the trend to set up more office locations outside the UK and the US is set to continue. In the first two months of 2010, more than a dozen multi-billion dollar international hedge funds have set up or re-established a presence in Hong Kong and Singapore. Fund managers are attracted by friendly policies and fast economic growth in the region as well as lower operating costs offered by the Asian hedge fund centres. Additionally, the ease of setting up shop in Asia is now in stark contrast with financial centres in the West like New York and London, where governments are proposing more taxes and greater regulations for hedge fund managers. Besides Asia, hedge funds in London and other European countries are considering shifting offices to Swiss financial centres such as Geneva, Zurich and Zug. The number of hedge funds setting up in Switzerland was already increasing and the recent measures by the UK government to impose higher taxes on investment managers and the European Union’s proposals to impose restrictions on hedge fund borrowing could push more managers to move their offices into Swiss cities.
Figures 8a-8b: Hedge Fund Head Office Locations by the Years
Figure 9: Hedge Fund Domicile Locations in 2009
The Cayman Islands continues to be the domicile of choice for hedge funds due to the availability of service providers, ease of structuring a Cayman Islands fund as well as tax efficiency. Local regulations have never taxed income, property, corporate earnings, retail sales or capital gains and many corporations in heavy tax-laden countries consider it a tax haven. Unlike the other Caribbean islands that bank on tourism, Cayman Islands built their wealth serving as a tax haven centre for businesses. However, regulators in Europe and the US have been criticising offshore fund centres and their tax policies and hence, as a response to international pressure, the Cayman Islands have increased their company and partnership registration fees.
Fees, High-Water Marks and Prime Brokers
We have also observed some significant trends in the fee structures of global hedge funds. Although average annual management fees have not changed significantly as they are reasonable and competitive with the fees charged by other investment vehicles such as mutual funds, there has been a significant change in the average performance fees of hedge funds launched in 2009.
Table 2 shows the average fees charged by funds launched over the recent years. The fee structures of new launches remained similar until 2008 and it was only after the financial downturn that managers responded to calls from investors to lower their performance fees. However, a change from 19.5% to 17.6% is not as great as one would expect, which suggests that managers launching new funds and those that navigating the financial crisis skilfully are confident about delivering positive returns in all market conditions in the future.
Table 2: Average Hedge Fund Fees by Launch Year
Year
|
Average Performance Fees (%)
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Average Management Fees (%)
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2004
|
19.50
|
1.60
|
2005
|
19.78
|
1.68
|
2006
|
19.62
|
1.66
|
2007
|
19.54
|
1.74
|
2008
|
19.24
|
1.64
|
2009
|
17.60
|
1.68
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Over the years, critics have attacked the standard hedge fund compensation model of 2% management fee and 20% performance fee and the criticism increased after the large negative performances of some high-profile managers in 2008. While it is true that many hedge fund managers lost money in 2008, a third of the managers were still profitable at a time when the S&P 500 declined by 40%. Comparatively, one out of every 1,700 mutual fund managers made money in the same period, which means that investors were 50 times more likely to make money when parking money in a hedge fund as opposed to parking money in a mutual fund. The fact remains that investors are generally more concerned over net-of-fees returns and hedge fund investors can still realise net 15% compounded gains a year even if hedge funds charge 20%, 30% or even higher performance fees.
Table 3: Funds above High-Water Mark
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As discussed in the section on launches and closures, the rate of hedge fund closures decreased during the second half of the year as managers started witnessing capital inflows as well as performance-based gains. The strong profits made by managers in the post-March period saw many of them crossing their high-water marks and accruing performance fees again, hence relieving operational cost challenges as well as redemption pressure. As shown in Tables 3a and 3b, the percentage of managers above their high-water marks had increased to more than 32% in December 2009 versus only 15% in March 2009.
The figures in Tables 4a-4b, which give the share of the prime brokers in 2007 and 2009, are based on data reported to the Eurekahedge databases by hedge funds themselves and not by prime brokers.
Tables 4a-4b: Top 10 Hedge Fund Prime Brokers in 2007 and 2009 by Assets under Management
End 2007
|
End 2009
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Prime Broker
|
Market Share (%)
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Prime Broker
|
Market Share (%)
| |
Morgan Stanley
|
20.03%
|
Goldman Sachs
|
17.68%
| |
Goldman Sachs
|
18.48%
|
Morgan Stanley
|
16.25%
| |
Bear Stearns
|
14.71%
|
JP Morgan
|
14.11%
| |
UBS
|
7.82%
|
UBS
|
8.80%
| |
Deutsche Bank
|
5.87%
|
Deutsche Bank
|
8.16%
| |
Citigroup
|
4.18%
|
Credit Suisse
|
7.00%
| |
Credit Suisse
|
4.03%
|
Barclays
|
5.55%
| |
Lehman Brothers
|
3.58%
|
Citigroup
|
3.57%
| |
Merrill Lynch
|
2.89%
|
Merrill Lynch
|
2.76%
| |
Bank of America
|
2.45%
|
Newedge
|
2.10%
| |
Others
|
15.96%
|
Others
|
14.02%
| |
The prime broker industry for hedge funds has also gone through some significant changes over the last two years. Before the financial crisis, it was the prime brokers that had put in measures for counter-party risk; however, after the crash of two of the largest financial institutions, fund managers are now also wary of over dependence on a single prime broker. There is an increasing trend of hedge funds subscribing to multiple prime brokers, bucking the earlier trend of depending on one institution only. Some managers have also started moving their prime brokerage accounts to deposit-taking banks with balance sheets that are perceived to be more secure.
Performance Review[3]
The global hedge fund industry Index delivered remarkable returns in 2009, witnessing some record performances during the course of the year. The Eurekahedge Hedge Fund Index gained 19.54% – the best yearly returns since 2003 – while regional managers in North America, Europe and Asia ex-Japan delivered the highest returns on record since 1999.
The global hedge fund industry started 2009 on a cautious note after witnessing the worst year on record, performance-wise, in 2008. Although managers had significantly outperformed global markets during 2008 by losing only 11.14% on average as opposed to the 40 to 60% declines in underlying markets, hedge funds were under unprecedented performance and redemption pressures at the start of 2009 due to widespread panic among investors, especially after the Madoff scam in December.
However, with the turnaround in global financial markets in March 2009, the sector bounced back admirably, taking advantage of rallying markets, buoyant investor sentiments and increased risk appetite. Furthermore, although some market indices returned higher figures for the year, hedge funds have outperformed the underlying markets over the longer term. Taken over a four-year period, hedge funds have posted 37.7% total returns while the MSCI World Index posted a decline of 7.1%, indicating that the managers beat the broad equity markets by 44.8%. Additionally, annualised volatility of hedge funds (with reference to its standard deviation) was 6.6% in the last four years while stock volatility was 19.1%. As such, hedge fund managers were not only able to command much higher returns over the markets but also achieve this commendable performance with three times less volatility.
As demonstrated in Figure 10, the performance of hedge funds and global markets were closely related in 2006 and 2007, which were years characteristic of the prime expansion phases of the global economy. The two years saw robust company earnings and exponential growth in several regional economies – an upside which hedge funds were able to capture – while in the subsequent downturn from 2008 through 1Q2009, managers demonstrated their ability to protect capital.
Figure 10: Performance of Global Hedge Funds vs Stocks (January 2006 to December 2009)
In addition to the outperformance over the underlying markets, hedge funds have also delivered greater returns over other alternative investment vehicles such as funds of funds and long-only absolute return funds. Figure 11 shows the four-year performance track of hedge funds, funds of funds and absolute return funds Although funds of funds have a positive correlation with hedge funds, they still underperformed the single managers by 30%, with the difference in performance widening in the last two years. In 2006 and 2007, the performance difference between hedge funds and funds of funds was 300 basis points, but this number increased to 870 in 2008 and 970 in 2009. Many fund of funds managers faced extraordinary redemption pressures in the last two years due to their exposure to the Madoff scam and resultant bad publicity.
When compared with long-only absolute return funds, hedge funds achieved a higher Sharpe ratio over the last four years due to a smaller volatility denominator. In fact, the annual standard deviation of long-only absolute return funds was 18.1%, which was more than twice the volatility of hedge funds of 6.6%. Many long-only absolute return funds are run by value managers who adopt a passive long-term view of their investments and would not be very concerned with short bouts of volatility in the market. Unlike these managers, global hedge fund managers actively monitor their positions in the market and would actively resort to short positions to hedge their exposures.
Figure 11: Comparative Performance across Absolute Return Vehicles (January 2006 to December 2009)
Figure 12 shows the volatility performance of hedge funds and funds of funds for the past nine years, taking the Eurekahedge Global Hedge Fund Index and Eurekahedge Global Fund of Funds Index as references. Both indices have witnessed an increase in volatility in the past few years; however, funds of funds remain less volatile than hedge funds. In fact, the volatility of funds of funds was lower than hedge funds during 2001 to 2004 and more recently, during 2009. The record losses seen during 2008, which saw fund of funds down by 19.6%, had the effect of significantly increasing their volatility. However, with the lower standard deviation that funds of funds provide, they remain beneficial to an investor’s portfolio from a diversification perspective.
Figure 12: Rolling 6-Month Annualised Volatility of Hedge Funds and Equities
Breaking down the performance by regional mandates, the best performing regions in 2009 were Asia ex-Japan and Latin America (which are also the best performing regions in the longer time frame). Robust economic recovery, market performances and increasing investor preference to allocate more capital into the emerging markets have helped the managers to deliver greater returns over the years. Additionally, emerging markets hedge fund managers have been able to improve performance by utilising the increasing array of complex products on the Asian exchanges which gives the managers greater flexibility in employing their preferred strategies.
Asian ex-Japan managers achieved the best performance across regional mandates in 2009. The Eurekahedge Asia ex-Japan Index posted 37.34% returns last year, which is the best annual performance across all regional indices on record, while Latin American hedge funds also posted noteworthy returns of 26.92%. The performance of fund managers investing in Latin America was adversely affected by the Mexican swine flu scare, but managers were still able to deliver the highest returns since 2003.
European and North American hedge funds also saw the best year on record in 2009. The two regions host the largest hedge funds in the world and hold the greatest number of hedge funds globally and despite going through the worst recession since the Great Depression, European and North American hedge funds emerged out of the crisis with new records under their belts. The Eurekahedge North America Hedge Fund Index returned 23.39% for the year while the Eurekahedge Europe Hedge Fund Index was up 22.01%.
Figure 13: Performance of Global Hedge Funds across Regions (January 2006 to December 2009)
Table 5: Performance of Global Hedge Funds across Regions (January 2006 to December 2009)
Eurekahedge North American Hedge Fund Index
|
Eurekahedge European Hedge Fund Index
|
Eurekahedge Asia ex-Japan Hedge Fund Index
|
Eurekahedge Japan Hedge Fund Index
|
Eurekahedge Latin American Hedge Fund Index
| |
2009 Returns (%)
|
23.40%
|
21.97%
|
37.45%
|
6.73%
|
26.94%
|
3-Year Annualised Returns (%)
|
9.63%
|
4.75%
|
14.28%
|
-1.99%
|
14.30%
|
Annualised Standard Deviation (%)
|
6.34%
|
8.58%
|
12.76%
|
6.37%
|
6.23%
|
Sharpe Ratio
|
0.89
|
0.09
|
0.81
|
-0.94
|
1.65
|
Maximum Drawdown
|
-12.11
|
-23.14
|
-30.12
|
-16.96
|
-10.10
|
% Below HWM
|
0.00%
|
-4.70%
|
-0.83%
|
-8.59%
|
0.00%
|
When comparing performances by size, returns from larger global hedge funds exceeded smaller funds over the last four years. Larger hedge funds were able to allocate more resources for research and had greater ability to attract and retain talented managers. Moreover, they were able to have better access to companies and possess greater bargaining power with brokers and dealers. However, being large does not always equate to better future performances. For example, large hedge fund (> US$500 million AuM) performance surpassed smaller funds (managing US$100-500 million AuM) in the first three years (ie, 2006, 2007 and 2008), but in 2009, the Eurekahedge Large Hedge Fund Index posted 19.28% while the Eurekahedge Medium Hedge Fund Index delivered 22.3% returns in the same period. While smaller funds are able to put all their capital in the best ideas, larger funds find it more difficult to put continued inflows to work due to the constraints of internal asset allocation guidelines and polices.
Figure 14: Performance of Hedge Funds across Sizes (January 2006 to December 2009)
In terms of strategic mandates, 2009 also witnessed some record performances, particularly from event driven and distressed debt managers, while long/short equity and arbitrage hedge funds also delivered admirable returns. Event driven hedge funds were well-positioned to take advantage of the global economic turnaround and although M&A activity was down in 2009 (as compared to the previous years), there were many low-value opportunities available to companies with strong balance sheets and the hedge funds employing this strategy were well-positioned to capitalise on the various deals and corporate actions during the year. Furthermore, managers who had invested in distressed securities and debt obligations delivered exceptional performances, profiting from the continued low prices of high-quality debt trading at deep discounts.
The Eurekahedge Event Driven Hedge Fund Index gained a massive 38.63% in 2009, which is the highest annual return on record across all broad hedge fund strategic indices, while the Eurekahedge Distressed Debt Hedge Fund Index posted 35.96% gains beating its own previous high of 33.60% in 2003. Furthermore, all other strategic indices returned positively for the year as the simultaneous rise in debt and equity markets presented excellent prospects for the managers to make hefty profits. Long/short equity, fixed income, arbitrage and relative value managers also witnessed the best year on record for their respective indices.
The global economic recovery in the last year led most hedge fund strategies to reach new index highs at the end of December 2009. The two strategies that were evidently lower were long/short equity managers and CTA/managed futures. This was because of the higher historical volatility levels associated with the two strategies as they engage in trading of leveraged instruments in commodities, currencies and stocks which tend to exhibit larger daily ranges compared to bonds. From a three-year perspective, however, CTA/managed futures trading has been the leading strategy as managers saw exceptional gains in 2008 as the majority of the trend followers were able to capture gains from a strong downward directional market.
Figure 15: Performance of Hedge Funds across Strategies (January 2007 to December 2009)
Table 6: Performance of Hedge Funds across Strategies (January 2007 to December 2009)
EH Arbitrage Hedge Fund Index
|
EH CTA / Managed Futures Hedge Fund Index
|
EH Distressed Debt Hedge Fund Index
|
EH Event Driven Hedge Fund Index
|
EH Fixed Income Hedge Fund Index
|
EH Long / Short Equities Hedge Fund Index
|
EH Macro Hedge Fund Index
|
EH Multi-Strategy Hedge Fund Index
|
EH Relative Value Hedge Fund Index
| |||
2009 Returns (%)
|
23.57%
|
2.41%
|
35.71%
|
39.12%
|
23.69%
|
23.29%
|
12.68%
|
21.10%
|
22.39%
| ||
3-Year Annualised Returns (%)
|
6.95%
|
11.98%
|
4.77%
|
8.61%
|
3.30%
|
4.01%
|
9.99%
|
7.86%
|
8.03%
| ||
3-Year Annualised Standard Deviation (%)
|
6.25%
|
7.42%
|
10.82%
|
10.71%
|
7.14%
|
9.80%
|
4.47%
|
6.75%
|
6.67%
| ||
Sharpe Ratio
|
0.47
|
1.07
|
0.07
|
0.43
|
-0.10
|
0.00
|
1.34
|
0.57
|
0.60
| ||
Maximum Drawdown
|
-11.74
|
-3.71
|
-28.50
|
-21.27
|
-15.85
|
-22.87
|
-3.96
|
-12.33
|
-11.21
| ||
% Below HWM
|
0.00%
|
-1.65%
|
-0.24%
|
0.00%
|
0.00%
|
-3.30%
|
-0.19%
|
0.00%
|
0.00%
| ||
In Closing
The last two years have shown that global hedge funds are actively responding to the challenges they face and that the industry is in a constant state of flux. Hedge funds have outperformed most other asset classes over the last few years, displaying not only their ability to protect capital in a downturn but also to capture most of the upside in rallying markets. Additionally, in response to investor demands, hedge fund managers have already started to adjust their fee structures while changes in the prime broker and administrator landscape are meant to foster greater risk management and transparency. However, with ongoing debates on regulations and increasing demands from investors on various issues (such as liquidity), hedge fund managers are taking further steps to address these concerns, an example being the rising popularity of hedge funds launched under the UCITS III regulatory framework – the next section discusses this new investment class in further detail.
Going forward, we expect hedge funds to outperform the underlying markets in 2010 and also to witness greater inflows (as investors respond to the abovementioned measure and also take note of the significant outperformance over the years) to end the year with assets above US$1.68 trillion.
