13/04/2011 Author: Will Wainewright

First quarter storm

After a turbulent first three months of the year, HFMWeek took the temperature of the industry to see how hedge fund investor sentiment has reacted to recent global volatility and market uncertainty

The first three months of 2011 always faced a challenge to compete with the last quarter of 2010, during which time hedge fund assets increased by nearly $149bn - the biggest three-month rise in the industry's history. However, though market turbulence has undoubtedly contributed to some mixed performance, Q1 2011 has proved a healthy start to the year when measured in investor interest. February saw inflows of $34.9bn according to figures published this week by BarclayHedge and TrimTabs Investment Research, their highest recorded monthly figures. "Investors are continuing to come back to the industry," Kenneth Heinz, president of Hedge Fund Research, told HFMWeek. "Despite March's market uncertainty, funds are generating pretty steady performance and investors are responding."

Other industry sources agree that a tumultuous period for equity markets, shocked by events in the Middle East and Japan, has not left investors running scared. "Our clients don't really look at three-month returns that much, to be honest," says Guy Saintfiet, head of UK liquid alternatives at Aon Hewitt. "There has been a lot of volatility but I think it's more about the long-term trends of the market."

Mairead Kenny, head of European capital introduction at Bank of America Merrill Lynch (BofAML), believes the industry's apparent immunity from short-termism is a result of the increasingly institutionalised nature of its investor base. "Because a lot of the assets coming into the industry are originating with institutional investors, who have a very long-term investment horizon, turbulence in one month isn't going to impact their five-year investment plan."

Kenny thinks inflows have looked strong in the first quarter, driven by interest from the institutional investor base. She says this growing institutional interest in hedge funds is a continuation of a trend seen over the last 12 months, pinpointing pension funds in Europe and retirement funds, endowments and foundations in the US as key drivers.

James Lewis, head of Europe at investment consultancy firm Albourne Partners, offered an example of this rise. "A key theme we are seeing in the institutional space in Europe is UK Corporate Pension Plans building direct portfolios. This is a change from two or three years ago." Louis Kahl, co-head of hedge fund research at Hewitt EnnisKnupp, told a HFMWeek Breakfast Briefing audience last month that public pensions have been boosting their hedge fund allocations since Q4 2010.

In common with other investment advisors HFMWeek spoke to, Lewis reported on a strong first quarter, which showed, above all, that the trends of 2010 are continuing. "We have seen capital being deployed to hedge funds quite meaningfully over the last year, with allocations often coming from the equity part of portfolios. I don't think anything has changed significantly this quarter, though we have seen renewed interest from the family office network."

Paul Dackombe, head of UK institutional clients at Man Group, backs this up, saying that fund inflows have been strong. For Man, they amounted to $5.3bn (+$0.7bn net) in Q4 last year - the firm's healthiest figures for some time - and Dackombe believes the last three months will be similarly impressive. "We've seen strong inflow in the first quarter and strong pipeline going beyond there," he told HFMWeek. "The appetite for investors looking at hedge funds has definitely come back strongly."

Dackombe added that the first week of trading in January saw what felt like a quarter's worth of business. Such bullish sentiments - from a firm that experienced a fair amount of upheaval last year - bodes well for the industry at large.

So the investor outlook seems clear; institutional clients have continued showing interest, allowing the industry to perform strongly in difficult conditions. But what hedge fund strategies have caught the eye over the last three months?

Here the picture is more mixed. Macro strategies proved most popular with new investors in Q4 of last year, receiving $6.6bn of new capital allocations, and Aon Hewitt's Saintfiet thinks the trend has continued into the first quarter. "Strategies which have been very popular have been macro and CTA. We have probably done more allocations in those strategies in the last year, including the last three months, than average."

Kenny says BofAML investors have shown good appetite for macro too, but two other strategies - the return to fund of funds aside - have been more popular. "The number one place we are seeing interest right now is long-short equity, followed by event-driven," she says. Others reported strength in these areas, but definitive trends were hard to pin down.

Ultimately, the story of the quarter appears to be the onward march of the institutional investor. It may not be the newest of themes, but its importance in helping the industry to ride out a period of uncertainty should not be understated.