Six Month Review: The Year so Far for Hedge Funds
Mayan literature prophesised 2012 would be the apocalypse and for most Greeks, Spaniards, Italians and Portuguese, it probably will. Fortunately for hedge funds, the year has been fairly fruitful with the majority of strategies delivering positive returns, with the average hedge fund up 5% Year-to-Date (YTD), and posting the best first quarter results in five years. Assets under Management (AuM) hit $2.13 trillion, surpassing the previous $2.04 trillion record set in 2011 as investors regained confidence in alternatives. Inflows were most pronounced into fixed income relative value and macro despite the latter delivering just 0.24% returns YTD. However, now is not a time for hubris or complacency. The industry is facing serious challenges which could yet make 2012 an annus horribilis.
If laws of economic logic prevail, a Greek exit from the eurozone is all but inevitable while speculation mounts over whether the equally imperilled Spain will follow suit. Most pundits suspect a Greek exit will be painful albeit manageable although Spain would be a whole new level. The risk of contagion remains high with several European banks in perilous shape. Hedge fund managers, speaking at industry conferences, anticipate the eurozone crisis will have serious knock on effects globally, with Asia being particularly badly hit. Hedge funds must be prepared to confront the operational challenges of at least one eurozone country exiting the union. Counterparty risk, investment risk, investor risk, legal risk and financing risk must be taken into account. Credit Suisse’s investor survey reveals counterparty risk is again being taken very seriously by investors in light of the eurozone crisis (and MF Global’s collapse). Fortunately most hedge funds appear to be far more prepared for such eventualities than they were in 2008.
The latest AIFMD draft by the European Commission was a kick in the balls for the hedge fund industry and significantly diverged from the ESMA guidance, specifically around depositary liability and third country provisions. Nevertheless, these proposals are not final and there has been considerable pushback by the industry and several countries. Managers are slowly getting to grips with the onerous Form PF while CTAs and CPOs face registration requirements with the CFTC. On top of that, FATCA continues to frustrate managers although some organisations are lobbying US officials to delay its January 1, 2013 implementation date. The Financial Transaction Tax appears to be on the backburner as European politicians and regulators face distractions elsewhere – nevertheless, it could still yet be thrust into the limelight. The push for mandatory clearing of swaps is gaining momentum in the US although EMIR is unlikely to be published until year-end 2012. Compliance professionals express concerns that regulatory arbitrage between the US and EU could undermine the rules. There are also many other nasties on the horizon, particularly in the EU. CSD rules will cut liquidity and increase investor costs in the international debt markets. MiFID II is likely to increase reporting requirements. To cap everything off, several European finance ministers are apparently quite enamoured with pushing for an EU equivalent of FATCA.
Despite the market turbulence, M&A is back in fashion .Perhaps the biggest and most unexpected deal this year was Man GLG’s decision to acquire Financial Risk Management (FRM), the $9 billion fund of funds. The deal, which is subject to regulatory approval, will create the biggest non US fund of funds on the market. A bold move, some may say, given that Man GLG has been on the back foot for most of 2012 following a lacklustre performance alongside its below par share price. Gottex, a Switzerland-based fund of funds purchased Penjing Asset Management in Hong Kong as the firm furthers its expansion into APAC. The M&A bug has been caught by fund admins too. SS&C Technologies looks likely to acquire GlobeOp in a deal which has not impressed upon some fund managers, who suspect the JV could frustrate their operations. Meanwhile, Goldman Sachs Fund Administration is on the market although a buyer has not yet been forthcoming. Merlin Securities, a mid-sized prime broker, was purchased by Wells Fargo Securities as the San Francisco-based bank makes its first foray into prime services.
Investment consultants’ stranglehold on institutional investors continues unabated. According to Goldman Sachs Prime Brokerage survey, 48% of institutional investors employed consultants, while 49% used consultants to carry out operational due diligence. It is not unrealistic to assume investment consultants control roughly two out of every five investment dollars in hedge funds. These organisations, whose client base tends to include inexperienced pension funds, generally allocate to brand name managers. Critics point out this leads to correlated returns and is mirroring the failed funds of funds model pre-2008.
Prime brokerage surveys often make miserable reading for newly launched or emerging hedge funds. The 2012 crop would be no exception. According to Citi Prime Services, investors allocated a mere $5.6 billion into 352 early stage or day one hedge funds during 2011 bringing the total capital allocated into start-ups to $12.4 billion since 2009. A previous survey, also by Citi, revealed that the 13% of managers with more than $1 billion in Assets under Management (AuM) control the overwhelming majority of the $1.7 trillion in total investor capital. Emerging managers are continuing to feel the pinch. Furthermore, seed deals are very few and far between, prompting one industry expert to question whether seeding vehicles were a sustainable business.
Written by Charles Gubert