11/01/2012 Author: Tony Griffiths

2012: What lies ahead

In what promises to be an unpredictable year for hedge funds, HFMWeek takes on the unenviable job of predicting the main themes to look out for in the coming 12 months

Bidding adieu to 2011 with a sigh of relief, the hedge fund industry is now steeling itself for a similarly uncertain 2012. There is little doubt that the year ahead will prove testing: the European debt crisis shows few signs of abating, with many expecting it to come to a head before year-end; several key national governments are due an overhaul; and markets remain wildly unpredictable. Still, as ever, the dark clouds above are not without rays of sunlight – most notably in the form of an increasingly loyal, adventurous and sizeable institutional investor base that is looking to put capital to work.   

HFMWeek spoke to a range of hedge fund professionals in an effort to form a selection of likely trends and predictions in this, the most unpredictable of climates. A fool’s errand? Perhaps. But, in a year to be defined by challenges, it seems as good a tone to set as any.     

Performance struggles
It has not been, and will not be, easy to perform for anyone in 2012, says Stefan Keller, head of research for Lyxor Asset Management’s managed account platform. “Last year bears testimony to an investment environment where emotions have not been easy to control. With major elections in four out of five permanent UN security council members and as governments and central banks will continue to intervene everywhere, we do not expect 2012 to be less emotional than 2011. As a result, systematic and model-based kind of managers could continue to outperform. Strategy-wise these managers are to be found in the equity quant, CTA and global macro buckets.”

Unsurprisingly, tempered performance expectations are echoed widely. Many interviewees suggested a “focused” or “cautious” optimism for 2012 returns. “With interest rates at very low levels and prices being driven by macro and, especially, political factors – rather than fundamentals – it could be difficult for some hedge fund managers to produce the kind of returns we have seen in the previous decade,” says Tommaso Mancuso, head of research at fund of hedge funds (FoHF) manager Hermes BPK. “The extreme volatility we have seen in 2011 has caused some managers to rethink their hedging strategies and reduce basis risk.”

Omar Kodmani, company president of $21bn FoHF Permal Asset Management, meanwhile, is a little more optimistic – using past success as a guide. “If historical patterns hold, 2012 could be a year of vigorous above-average returns, similar to 1999 after 1998, 2003 after 2002, and 2009 after 2008,” he notes.

Inflows continue
Markets may make it a difficult year for performance, but the consensus appears to be that inflows in 2012 should be healthy. “It’s still a difficult investing environment but a better year in 2012 for asset raising, which had already started at the end of 2011, with pension funds leading the way,” says Stephen Foster, COO, single manager hedge funds, at Credit Suisse.

US institutional investors will remain keen, although, according to Phillip Chapple, executive director at investment consultant KB Associates, significant new inflows appear to be coming from European corporate pension funds. “From my discussions, it appears that the average investor from this space is increasing their allocation to alternatives by around 2%,” he says.

“Investors have seen alternative investments in their portfolio generate better risk-weighted returns than the long-only investments in their portfolios, and due to counterparty risk concerns, cash is not seen as quite the safe haven it once was,” Chapple continues. “Many pension fund managers have been beaten up on the size of their cash balances – investors just haven’t got any value from this in return for counterparty risk. There is pressure on investors to put money to work.”

“I think a broad shift away from the traditional bond and stock style of portfolio management is becoming more and more of a reality,” says Barny Cardwell, CEO of London-based CTA Cardwell Investment Technologies. “Managed futures have been growing in AuM in light of this so I expect an increase in assets there again this year.”

Investor expectations are “more realistic” than they have been in previous years, the CIO of one multi-billion-dollar, London-based systematic hedge fund told HFMWeek. He expects this to work in the industry’s favour in 2012.

From big to small
Asset inflows in 2011 continued to consolidate to the very largest managers in the industry and this is likely to continue during the first few months of 2012. Credit Suisse’s Foster expects the winners to be large, established funds or high-profile start-ups; of which “there could be several” he adds. Permal’s Kodmani agrees. “I would not be surprised to see more manager spin-offs and a few big fund launches,” he says.

The mortality rate of small and medium-sized hedge funds is bound to increase, adds Hermes BPK’s Mancuso, as regulatory requirements and anaemic performance of the last couple of years greatly reduces profitability and increases the minimum critical mass needed to survive. “Also, the number of FoHFs is bound to decrease,” he says. “These were the natural investors in small-to-medium-sized hedge funds. The survivors will have to adapt and become more sophisticated.”

However, HFMWeek interviewees also suggest that, while raising assets will be no walk in the park, smaller managers have reason to be optimistic. Many large managers are becoming saturated, forcing more adventurous investors to look further down the ladder, while Lyxor is, in fact, seeing demand for medium-sized managers.

KB Associate’s Chapple goes one step further. He believes some investors saw giving money to the big, safe managers as a bit of a stopgap. “Now investors want higher alpha and more exciting opportunities, so are looking at smaller opportunities.”

Speaking to cap intro professionals and investment consultants, HFMWeek can put forward global macro, distressed credit and event driven as widely tipped successes for 2012. Systematic funds are also expected to continue to magnetise investment.

Dig deeper and more niche opportunities, such as emerging market global marco, European distressed and multi-strategy credit are also attracting attention. Distressed debt strategists Sothic and Fortelus were two funds name-checked as being on a number of investor radars. 

China uncertainty
“Our economists expect that 2012 will be a year of slowing global growth with wide divergences between regions and countries,” says Marion Mulvey, head of alternatives for Emea at Citigroup’s admin division. “We expect China’s growth to slow markedly, but global growth will still be Asia-led. The euro area is falling back into recession and only modest growth is likely for the US.”

Jim Chanos, founder of hedge fund Kynikos Associates, maintained his long-held bearish stance on China during 2011, even suggesting in November that Australia could suffer due to its economic ties to the country. Talk of a Chinese real estate bubble has persisted, while Chinese stock markets were among 2011’s worst performing. However, recent news that China is this month to offer more concrete plans for its new short-selling regime has piqued interest.  

While there is a general consensus that Asia will see growth, Mark Martyrossian, partner at Asia-focused boutique Tiburon Partners, sees Chinese opportunities. The Sino Forest-led sell-off “has uncovered some very cheap stuff in China”, and “beaten up consumer plays, in China and Australia in particular, are way oversold,” he says.

“While our very negative view of the big picture in the Western hemisphere has not changed, our stance in Asia has.” Tiburon kept the hatches battened down for much of the first half of the year – not so much because of concern about the macro condition of Asian economies but more because of the likely impact of Eurozone worries – and, after several months of dreary performance in Asia, Martyrossian is now seeing value appear in a number of sectors. 

More defensive Asia-Pacific stocks that played an integral part of the portfolio earlier in the year – Singaporean banks, Australian utilities, consumer staples – have been replaced with higher beta names that have taken a real drubbing, he notes.   

Outlook
“The growth of institutional investor participation in the hedge fund industry, seeking lower volatility and higher quality returns across economic cycles, will continue and gain pace, as ongoing political and economic uncertainties likely lead to further market volatility in 2012,” surmises Todd Groome, chairman of global industry body Aima.  

Many HFMWeek interviewees see 2012 as a year of two halves, as, over the next few months, the global economy battles against persistent deleveraging and sovereign debt issues before reverting to period of heightened challenge in the second half of the year. Ultimately though, it’s almost too hard to call.  

“Our outlook for 2012 remains very cautious,” says Andrew Kenney, CIO at SAM Capital, echoing the general consensus. “High unemployment, unsustainable debt and a push for greater fiscal austerity across much of the developed world all point towards a challenging and volatile economic environment. We are in the middle of a secular deleveraging, so fasten your seatbelts and remain nimble – there’s more turbulence ahead.”