Hedge Fund and Absolute Return Strategies

Transcription

1 Fund & Asset Manager Rating Group Sector Update March 11 Contents Highlights...1 Hedge Fund and Absolute Return Strategies Highlights Increased allocations to hedge fund and absolute strategies from institutional investors have materialised in as they look to diversify sources of performance out of mainstream risk assets. In Fitch Ratings view, this post financial crisis change is structural, partly driven by regulation changes that push institutional investors to take active risk while satisfying regulatory de risking of their balance sheet. Fitch considers that hedge funds and most absolute strategies served their purpose in on a risk adjusted performance basis. Yet, the performance of Newcits (regulated funds managed by HF managers) has been rather disappointing in, raising the question of the validity of this new market segment. Global macroeconomic imbalances combined with trend reversals provided opportunities to relative value oriented strategies. Meanwhile, rising risk appetite and the progressive appearance of clearer macro trends in Q favoured directional strategies until another sharp trend reversal in late ruary 11. Some of the successful long beta calls (narrowing credit spreads, rising equities, rising emerging markets) are being reassessed in the face of current valuations, rising geopolitical risks, potentially weaker growth, higher inflation and ongoing fiscal consolidation. New banking rules are transforming proprietary trading desks and market making into third party management activities, thereby potentially increasing the contribution of the hedge fund industry to systemic risk. Sector Trends... Performance: Good End to... Stronger Flows to HFs as Investors Look to Diversify Sources of Risks and Return...3 Market Commentary... The Big Picture: Main Driving Themes in and Beyond... Strategies Review...5 Analysts Paris Aymeric Poizot, CFA, CAIA aymeric.poizot@fitchratings.com Charlotte Quiniou, CFA charlotte.quiniou@fitchratings.com Risk/Return Profile of Market Indices As at December HFRI FoF Composite index London Manuel Arrive, CFA manuel.arrive@fitchratings.com HFN FoFs Aggregate Index HFRI Fund Weighted Composite Index UCITS Hedge Index (The Hedge Fund Journal) S&P 5 index (price) Frankfurt Roger Schneider, CIIA roger.schneider@fitchratings.com Davie Rodriguez, CFA, davie.rodriguez@fitchratings.com Markit Iboxx US Treasuries (TR) Merrill Lynch IG Global Broad Market Index Non-Sovereign (TR) (1 month index in USD terms) New York Roger Merritt roger.merritt@fitchratings.com MSCI World index (price) S&P GSCI Index - Commodities (price) Sources: Fitch, HFR, HFN, Bloomberg month volatility

2 Sector Update Hedge Fund and Absolute Return Strategies Related Research Sector Update: Credit Asset Management (March 11) Sector Update: European Money Market funds (March 11) Reviewing and Rating Fund of Hedge Fund Managers ( June ) Reviewing and Rating Asset Managers (16 August ) Sector Trends Performance: Good End to Table 1 Return Figures Market and Alternative Investment Indices Hedge funds Cur. Jan 11 Q Q3 volatility /risk ratio correlation with S&P5 HFRI FoF Composite index USD HFRI Fund Weighted Composite Index USD UCITS UCITS Hedge Index USD.3 (Jan) Lipper Global Abs Retrn Med. EUR Market indices S&P 5 index (price) USD MSCI World index (price) USD Markit Iboxx US Treasuries (TR) Merrill Lynch IG Global Broad Market Index Non Sovereign (TR) S&P GSCI Index Commodities (price) USD USD USD Source: Fitch, HFR, UCITS Hedge, Bloomberg, The Hedge Fund Journal Q performance was driven by rising stock markets and stable volatility and spreads, until trends reversed in late ruary, thereby providing another test to the ability of absolute funds to provide downside risk protection. Equity and Interest Rates Implied Volatility (US) (index level) VIX Index (CBOE SP5 Vol) LHS MOVE Index (1 mth US Treasuries) RHS (index level) Merrill Lynch IG Global Broad Market Index Non Sovereign, Asset Swap Spread (bps) May May May Source: Fitch, Bloomberg No v 7 M ay No v M ay M ay Source: Fitch, B loomberg

3 Fund & Asset Manager Rating Group Equity Market Indices (Base in. 7) May Aug Source: Fitch, Bloomberg S&P 5 index (price; USD) MSCI World index (price; USD) MSCI Emerging Markets index (price; USD) May Aug May Aug 11 US Interest Rates and Spreads (Yields, %) 6 7 Jan Mar May Jul Spread Y Y US treasury yields RHS LIBOR 3m (USD) LHS US Government Treasury Yield ( YR) LHS Sep Jan Mar May Jul Sep Jan Mar May Jul Sep (Spread, %) Jan Source: Fitch, Bloomberg Stronger Flows to HFs and absolute products Investors Look to Diversify Sources of Risks and Return Hedge funds as a whole have continued to accumulate net new client inflows throughout. Assets under management (AUM) peaked in Q. Using data from HFN.net, Fitch notes the following highlights 1. Q marks the sixth consecutive quarter of net new inflows, with new money of USD8.6bn in. Total assets in single manager hedge funds have reached USD.7bn in December, still about % below the historical peak of USD.9bn in Q. Flow to funds of hedge funds (FoHFs) are positive for (USD.9bn net new money in ) but do not show a clear sustained trend ( USD.35 in Q). Nevertheless, shows a stabilisation of their share of global HF assets channelling at 38% after a peak of about 5% in early. More generally, marked the rise of absolute funds managed by traditional asset managers. According to Lipper, the sector generated net sales of EUR.9bn in, a 6% rise on last year s activity. This reveals a fundamental change in the industry, as investors favour strategies able to provide more downside risk protection and lower beta exposure. Furthermore, the rise of sophisticated absolute funds managed by traditional long only managers may well provide investors with an alternative to certain types of hedge funds. Flows reveal a growing appetite from institutional investors to diversify sources of performance and downside protection. This is reflected in the following. The share of institutional investor portfolios dedicated to hedge funds has increased, on average, from % in to 1% in. FoHFs appear to be a vehicle of choice for building an alternative investments exposure, especially with small institutions according to the same survey, 8.5% of all respondents invested exclusively in HFs through FoHFs in (although down from 56% in ). Single strategy FoHFs have been preferred in, with USDbn of inflows (or 1.% variation on total FoHF AUM), as investors use them as a way to add a specifically identified alternative beta component to a diversified institutional portfolio. Investors seem to have favoured strategies with low equity directional bias (favouring market neutral), and low interest rate directional bias (favouring arbitrage). They also clearly bought the theme of a renewed corporate takeover activity alongside event driven opportunities across markets. Interestingly, emerging market (EM) focused HFs have attracted little new capital relative to traditional funds. Flows to EM HFs were USD5.8bn (as per HFN). This compared with EURbn of net sales of EM specialised funds domiciled in Europe (as per Lipper). This is because investors increasingly consider EM as a beta play, more cheaply and easily implemented using long only vehicles. 1 See HFN.net HFN Hedge Fund Industry Asset Flow/Performance Report Q See SEI / Greenwich Associates Survey of Institutional Hedge Fund Investors, Institutional Hedge Fund investing comes of Age, January 11 3

4 Sector Update Hedge Fund and Absolute Return Strategies Whether efficient performance providers or not, UCITS 3 compliant hedge funds are attracting a growing share of alternative assets. Total investments in such vehicles reached USD1bn at end and a recent survey by Deutsche Bank indicates the figure is expected to double in Liquidity and regulatory oversight are most often cited as drivers of growth. However, UCITS HFs have not yet convinced investors that they can provide them with a decent level of performance given: 1) very low risk taking (1.1% volatility as per the UCITS Hedge Index); ) a limited use of complex/illiquid strategies (best HF performers in ) for regulatory reasons; and 3) a low observed beta for downside limitation reasons. Linked to the popularity of Newcits funds, is the possible of investments in newly launched HFs or smaller vehicles in 11. This is in contrast to when the bulk of new assets went to HFs worth USD5.bn or more. With performance back, it is expected that many large HFs could close again to new investments, paving the way for newcomers: HFR reported a growing number of fund launches globally, from 1,197 in 7, down to 659 in, then 78 in and 8+ in. Market Commentary The Big Picture Main Driving Themes in and Beyond Hedge fund risk adjusted performance proved superior to traditional investments, from a shortand long term perspective, with volatility half that of global equities. The industry in general passed its former high watermark (HWM) reached in October 7 at some point in Q (not yet the case for FoHFs). It is estimated that 5% of HFs will be able to charge performance fees for their record 5 (vs 3% in and 16% in ). Performance was mainly derived from still improving liquidity conditions, low interest rates, generally enhanced business conditions and rising commodity prices. General and progressive rise in risk appetite throughout. HFs had started off on a low net exposure (long bias) basis (an explanation for their relative underperformance in absolute terms later in the year), which gradually increased throughout the year. Yet, pure fundamental trades were not strong value generation engines in, as evidenced by the poor performance of market neutral equities. Global macroeconomic imbalances combined with trend reversals provided opportunities to relative value oriented strategies. Markets remain driven by pure macro plays and the of corporate activity, exacerbated by a macroeconomic environment that is providing ample opportunities to arbitrage markets based on themes of: commodities rising; inflation differential (developed vs. EM, US vs. EU); investment grade vs. high yield spread narrowing; falling volatility; government yield curves steepening; and divergence of currencies. While markets are expected to continue to be driven by macroeconomics and sentiment, stock picking based on bottom up research should play a bigger role in 11 onwards, especially in the credit space where valuations appear less attractive. Specifically, rising idiosyncratic risk is driven by a company s ability to refinance and its dependence on commodities and a particular country. New regulatory framework and investors constraints are having a noticeable impact on product engineering and hedge fund creation trends. In the US, the enforced Dodd Frank Act and its Volcker Rule have prompted numerous hedge fund start ups from former bank proprietary traders the corollary being that the market is now left more open to HFs to benefit from arbitrage opportunities. In Europe, investors need to find a way to take active risk while satisfying regulatory derisking (eg Solvency ), which calls for increased product transparency (via UCITS or managed account platforms). Institutional investors are also changing the way they deal with strategic vs. tactical asset allocation, active vs. passive investments and how they can capture the much sought alternative beta streams. The consequence is the need for alternative managers to continue developing their capacities in product structuring, portfolio optimisation, reporting and marketing. 3 See Deutsche Bank Hedge Fund Capital Group Survey of the UCITS 3 Industry, ruary 11 See Fitch s Fund of Hedge Fund Quarterly Q1 5 See TrimTabs investment research, January 11

5 Fund & Asset Manager Rating Group Strategies Review Table Return Figures Main Single Hedge Fund Strategies Jan 11 Q volatility /risk ratio Currency ref. Q3 Relative Value (HFRI Relative Value Total index) USD Macro (HFRI Macro Total index) USD Equity (HFRI Equity Hedge Total index) USD Emerging Markets (HFRI Emerging Markets Total Index) USD Event Driven (HFRI Event Driven Total index) USD Sources: Fitch, HFR, Bloomberg Commentary Strategy Relative value (fixed income and credit arbitrage, convertible bond arbitrage, multistrategy) Macro (global macro, CTA) Equity (long/short, market neutral) Event driven (M&A, distressed, special situations) Funds of hedge funds (FoHFs) perf. YTD Q Year 11 Commentary The best performing HF group in. Pure arbitrage trades worked well as liquidity has continued to improve thanks to continued quantitative easing and primary credit issuance reached record levels, especially in H, which helped many corporations refinance at favourable rates. Credit spreads have also behaved in different ways, as investment grade credit bottomed out and even rose in Q Q3 on the back of rising sovereign risk, while high yield credit spreads have continued to tighten. Sovereign yield curves also offered opportunities, getting steeper in H, along with fears regarding inflation and the issues in the euro area. Early in 11, relative value trades have continued to perform, yet the beta plays of (eg falling EM CDS spreads) have maybe come to an end, thus the need to pursue efforts in researching fundamental value in credit. The sector started off on the same uncertain footing as it had ended, thus lagging other HF strategies, as the inflation/deflation debate was still raging, thus prompting a market wide low volatility and range trading environment in early weeks. Risk appetite rose steadily, along with the appearance of clearer macro trends to follow, notably in FX, commodities, equities and yield curves. Gross exposure of macro/cta traders rose throughout, often to as high as % in December. Short term oriented traders fared better than longer term ones as they were better able to capture the rapid trend reversals in several markets. The novelty was that discretionary traders did not outperform systematic peers in. Now, with volatility at record lows (as measured by VIX below % in January 11) and exposure falling sharply at end, it remains to be seen how the sector will react to a potentially different trading environment. Equity HFs performed reasonably in, but very much in line overall with global long only markets, outperforming indices such as the MSCI World, but underperforming US only equities, thus the prevalent argument that performance is still largely driven by beta rather than pure alpha. Volatility, though, remains much lower than long only equities. Rising risk appetite is here too the main theme both net and gross exposure have risen sharply mostly in Q, often to 5% net long. Interestingly, concerns over inflation and political risk have had the notable effect that emerging markets have been shunned somewhat in favour of developed economies. Also, it seems HFs have favoured value equities as opposed to pure growth/ momentum securities, a potential sign of the current concerns over high market valuations. This is also a best in class in and early 11. M&A volumes (largely US) have risen steadily in, along with lower deal premiums. Such conditions should continue in 11 as corporations sit on large cash piles and as organic growth prospects look uncertain, corporate activity should be present, helped by still low credit spreads. Ripe for a new round of major restructuring include: financials, commodities and energy. After a good, the distressed sector is challenged by low and falling default rates, also compressed highyield spreads and good corporate refinancing conditions. This could mean that bottom up research, ie distinguishing between securities and sectors, may play a progressively bigger role from 11 onwards. The sector has continued to underperform single manager HFs in absolute terms, yet still proved a good diversifier by way of lower volatility and correlation. Fitch still sees a somewhat different future for FoHFs, especially if one takes for granted that a new breed of HF managers is coming to the market. As institutional investors look to raise their share of uncorrelated assets, it will be up to FoHF managers to demonstrate they can provide the effective portfolios and platforms to access those streams of s, ie convince investors that: 1) they have top quality research and the necessary seed money to identify and source the best upcoming HFs; ) their due diligence effort is the best shield against unexpected idiosyncratic risk; and 3) they can tailor or structure whatever risk//liquidity profile portfolio thanks to the use of advanced optimisation techniques and inclusion of new vehicles such as ETFs, managed accounts and derivatives based overlay, ie completely master the concept of alternative beta. 5

6 Sector Update Hedge Fund and Absolute Return Strategies ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE. Copyright 11 by Fitch, Inc., Fitch Ratings Ltd. and its subsidiaries. One State Street Plaza, NY, NY.Telephone: , (1) 9 5. Fax: (1) Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. In issuing and maintaining its ratings, Fitch relies on factual information it receives from issuers and underwriters and from other sources Fitch believes to be credible. Fitch conducts a reasonable investigation of the factual information relied upon by it in accordance with its ratings methodology, and obtains reasonable verification of that information from independent sources, to the extent such sources are available for a given security or in a given jurisdiction. The manner of Fitch s factual investigation and the scope of the third party verification it obtains will vary depending on the nature of the rated security and its issuer, the requirements and practices in the jurisdiction in which the rated security is offered and sold and/or the issuer is located, the availability and nature of relevant public information, access to the management of the issuer and its advisers, the availability of preexisting third party verifications such as audit reports, agreed upon procedures letters, appraisals, actuarial reports, engineering reports, legal opinions and other reports provided by third parties, the availability of independent and competent third party verification sources with respect to the particular security or in the particular jurisdiction of the issuer, and a variety of other factors. Users of Fitch s ratings should understand that neither an enhanced factual investigation nor any third party verification can ensure that all of the information Fitch relies on in connection with a rating will be accurate and complete. Ultimately, the issuer and its advisers are responsible for the accuracy of the information they provide to Fitch and to the market in offering documents and other reports. In issuing its ratings Fitch must rely on the work of experts, including independent auditors with respect to financial statements and attorneys with respect to legal and tax matters. Further, ratings are inherently forward looking and embody assumptions and predictions about future events that by their nature cannot be verified as facts. As a result, despite any verification of current facts, ratings can be affected by future events or conditions that were not anticipated at the time a rating was issued or affirmed. The information in this report is provided as is without any representation or warranty of any kind. A Fitch rating is an opinion as to the creditworthiness of a security. This opinion is based on established criteria and methodologies that Fitch is continuously evaluating and updating. Therefore, ratings are the collective work product of Fitch and no individual, or group of individuals, is solely responsible for a rating. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. Fitch is not engaged in the offer or sale of any security. All Fitch reports have shared authorship. Individuals identified in a Fitch report were involved in, but are not solely responsible for, the opinions stated therein. The individuals are named for contact purposes only. A report providing a Fitch rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of the securities. Ratings may be changed or withdrawn at anytime for any reason in the sole discretion of Fitch. Fitch does not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any security for a particular investor, or the tax exempt nature or taxability of payments made in respect to any security. Fitch receives fees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. Such fees generally vary from US$1, to US$75, (or the applicable currency equivalent) per issue. In certain cases, Fitch will rate all or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor, for a single annual fee. Such fees are expected to vary from US$, to US$1,5, (or the applicable currency equivalent). The assignment, publication, or dissemination of a rating by Fitch shall not constitute a consent by Fitch to use its name as an expert in connection with any registration statement filed under the United States securities laws, the Financial Services and Markets Act of of Great Britain, or the securities laws of any particular jurisdiction. Due to the relative efficiency of electronic publishing and distribution, Fitch research may be available to electronic subscribers up to three days earlier than to print subscribers. 6