If there’s one prevalent complaint among investors of all stripes, it’s that the majority of hedge funds “didn’t do what they were supposed to” during last year’s market collapse and subsequent economic downturn: hedge.
Which begs the question, “How good are hedge fund managers at predicting the future direction of markets anyway?”
A series of reports in the past week seem to suggest that although hedge fund managers aren’t sure which way markets are going, they aren’t complaining about rising markets.
According to a recent survey of hedge fund managers and other investment executives by RBC Capital Markets (conducted by the Economist Intelligence Unit), some 46% of these executives said they have low visibility about the macro environment, with “little or no confidence” in their ability to predict the direction of prices and rates in global financial markets (equity, debt, foreign exchange) over the next year.
Curiously, a fewer number (30%) said they lacked confidence in their ability to look out generally 12 to 24 months ahead.
There was little agreement. Two in five (42%) said they expected a gradual recovery over the next year, with growth resuming at a below-trend rate over the following year. But one-third (32%) were bearish, saying they did not anticipate a meaningful recovery for at least one year, followed by negligible growth at best.
“Fund executives believe that full recovery will be a slow, difficult process,” Marc Harris, co-head, Global Research, RBC Capital Markets, said in a release accompanying the report. “However, one of the benefits of the current climate of anxiety and uncertainty is that it produces a creative tension that can help make markets.”
Won’t get fooled again?
While we agree that it takes bulls and bears to make a market, we can’t help but notice that many hedge fund strategies still have a positive correlation with equities. A recent Goldman Sachs report showed that hedge fund long exposure was back at pre-Lehman levels (chart below):
And today we see reports that hedge funds continue to hitch their wagons to equity markets (“long/short rally continues as stocks soar.”)
This beta exposure may in turn be fueling investor enthusiasm for hedge funds. Despite a continuing decline in global hedge fund industry assets under management this year, a separate report released this week by UK-based Hedge Fund Intelligence predicts a rebound in AUM by the end of 2009, thanks to generally not-too-shabby performance.
Indeed, some 62% of the hedge fund managers surveyed said they believe that confidence is returning to their customers (or at least to their prospective customers).
Institutional shift out of equities an illusion?
You might expect the corollary of this confidence is a diminished role for traditional investments. We’ve covered the diminishing role of long-only equities in institutional portfolios on these pages for example. But now another report released this week paints a brighter picture for long-only managers.
The Conference Board recently found that the decrease in equity allocations by institutional investors was simply the result of the drop in equity values, not an active move out of the asset class. Says one of the reports co-authors:
“For decades, institutional investors had been shifting their allocation preferences from fixed-income securities into equity…Then last year came, and it had a devastating effect on institutions’ expanded equity portfolios. [By the end of 2008, institutions had only 36.6 percent of their assets in equities, down from 47.2 percent at the end of 2007.] And yet these revisions appear to have been driven by market declines rather than by changes in investment policies…”
The report’s summary does not seem to provide evidence of this assertion, however. Nor does it explain why these institutions have as yet rebalanced back to their strategic asset allocation targets.
Simply losing less than the equity markets last year may have helped alternative investments increase their share of pension fund portfolios. But the report also hints that alternative investment allocations continue to grow disproportionately:
“Overall, despite the recent correction, institutional investors remain committed to alternative investment strategies. The large asset manager foray into hedge funds appears to be the result of a number of factors, including the need to pursue higher returns and reduce volatility to meet actuarial projections, and the competitiveness of traditional investment strategies in stocks and bonds.”
Large asset managers making a “foray” into hedge funds? In part this may explain how the industry seems to be banking on continuing growth in equities…