Yesterday we argued that value-added, not “absolute returns” should be the key metrics in judging the recent success of hedge funds. Implicit in that argument is the assumption that hedge fund investors turn to the asset class for its diversification properties. After all, losing less than the markets in 2008 was only commendable if it was not achieved by simply un-levering a market ETF.
Today, we learned of a recent survey of institutional investors that found just that. According to Preqin (see other interesting research from this rather prolific organization) over half of institutional investors surveyed said they invested in hedge funds for diversification purposes. The runner-up reason was “to improve the risk/return profile” of their portfolio” – another reference to the diversification properties of hedge funds.
Curiously, the survey also found that investors are now far more concerned about all issues except fund performance. This time last year, over half said that the performance record was a “key consideration when choosing a hedge fund manager.” This year, the number has fallen to a third.
Although “firm reputation” is slightly less of a key consideration this year, the number who said “quality of personnel” is a key consideration jumped four times over the course of 2009. This may seem a little contradictory. But we can think of several examples of firms with stellar reputations that were headed by “low quality” personnel…
Amazingly, the survey found that the vast majority (65%) of respondents hadn’t lost any confidence at all in their hedge fund managers over the past year.
These findings stand in stark contrast to a report by the FT that hedge funds are suffering an “investor backlash.”
The article contains the usual complains about lock-ups, but then quotes one market participant as saying:
“In some cases, it benefited all investors to halt redemptions and wait out the liquidity crisis. Market conditions have improved and fire-sales have clearly been averted…”
The FT cites another player who makes a similar argument. Reports the paper:
“Most market practitioners concur that restructurings have been constructive, as they have helped managers to safeguard the interests of their funds and their investors…”
Such positive reviews for redemption gates are sure to take some of the wind out of the sails of hedge fund “backlash”.
Okay. No backlash. But according to Reuters, hedge funds are still “haunted” by high water marks. The news service says,
“…hundreds of managers remain deep in the hole and face some tough decisions in the coming weeks…”
But like the FT piece, this article acknowledges that the problem has all but gone away compared to a year ago. Reuters cites Credit Suisse research that found 45% of hedge funds are actually above their high water mark, and a further 20% had a legitimate shot at a performance bonus this year. Only about a third was going to get a lump of coal in their Christmas stocking this year.
The article concludes that,
“…strong returns have quieted dire predictions, especially among the largest and best known funds…”
Fewer “dire predictions” may be what’s behind the Preqin numbers above. But what can we expect from the industry over the final months of 2009?
Swinging for the fences…?
But will we start to see some managers “swing for the fences” as they clamor to get over their high water marks? With prescient timing, the Journal of Alternative Investments provides an answer to that very question in this quarter’s edition.
The article “Locking in the Profits or Putting It All on Black? An Empirical Investigation into the Risk-Taking Behavior of Hedge Fund Managers” by Andrew Clare and Nick Motson explores whether hedge fund managers actually start making big bets if they’re down as the year comes to a close.
Regular readers may recall our review of Claire and Motson’s original paper on the topic. The duo found that hedge funds who were down by year end tended not to ramp up volatility after all. However, funds that were up YTD did tend to ramp down volatility and lock in their profits.
…Or nudging oneself over the finish line
While 2009’s losers may not swing for the fences or “put all on black”, we may find that those who are tantalizingly close to break even may end up eking out a small gain on the year. After all, there’s nothing worse for a manager than a minus sign, right?
AAA regulars may also remember this 2007 study by Nicolas Bollen of Vanderbilt University and Veronika Pool of Indiana University that found an awfully fishy anomaly in the distribution of hedge fund returns – a dearth of “slightly negative results” (click to enlarge)…
The chances of this happening naturally, according to Bollen and Pool, are pretty small indeed.
It remains to be seen if these phenomenon play out in 2009. But it would appear that managers won’t have to make any strategic gambles or use any tactical tricks to impress institutional investors this year. At the very least, they’ll get a nice card this Holiday season.