29/09/2010 Author: Kapila Gohel

Navigating the market

As many large institutional investors consider their allocation strategies for the end of the year, HFMWeek takes an overview of the investor interest and performance across the range of hedge fund strategies, to see where investor sentiment is heading

With the summer marking the end of the fiscal year for many investors, the final quarter of 2010 is set to hit the hedge fund industry with a slew of institutional mandates.

Investors in the US have already started searching for hedge funds over many different strategies. While there is a clear trend in portfolios moving from funds of hedge funds (FoHF) to direct managers, searches coming from the US have started to become more specific and sophisticated when it comes to hedge fund strategies.

“Today, investors are looking at liquid strategies, mainly long/short equity, with liquidity being first and foremost in investors’ minds,” says Joe Genovese, director, Global Prime Finance Sales at Deutsche Bank in New York.

And as a result, a supply of long/short equity managers are lining up to meet these demands; according to data from Chicago-based Hedge Fund Research, of all the new hedge funds launched in the first half of 2010, the majority were long/short equity strategies.

Along with long/short funds, global macro and event driven are the strategies currently in demand, according to number of US prime brokers HFMWeek has spoken to. But there is also an increase in investors looking at credit-focused funds, as well as an upswing in demand for tail risk/long volatility strategies.

As the predominant strategy choice for most investors, long/short equity is seen as the natural option for an investor’s first move into hedge funds. However, despite the current wave of demand, the historical reliance on long/short funds is also changing. There have been a number of large new investors, such as the $134bn California State Teachers Retirement System (CalSTRS), that are specifically searching for global macro and have been much savvier when planning to make their first investment in hedge funds.

In fact, many investors are writing fairly large mandates for global macro hedge funds, says Lou Molinari head of Capital Solutions at Barclays Capital, and in turn macro funds have seen the second largest number of fund launches, according to HFR.

 “There is a desire to exploit current, past and future dislocations through global macro strategies,” he said. One theory for this move is that investors, frustrated with returns from investments in long/short equity strategies, while still paying 2/20, are taking more of an interest in macro themes.

While macro is increasing in popularity, not all investors are taking this path. The $138.6bn Florida State Board of Administration (SBA), whose investment team is headed by hedge fund veteran Ashbell Williams, is looking to steer clear of highly levered strategies, including global macro and quant funds, for its first move.

Earlier this year, SBA made its maiden investment in hedge funds through activist managers but will be adding more traditional strategies to the portfolio in future.

Another CIO with extensive experience who is taking their pension in an interesting direction is Lee Partridge of the $7bn San Diego County Employees Retirement Association (SDCERA), and formerly the deputy investment officer at the $92bn Texas Teachers Retirement System.

Partridge, who is revamping SDCERA’s hedge fund portfolio completely, told HFMWeek earlier this year about the firm’s intentions to move out of all the pension’s multi-strategy and credit funds and into global macro/CTA and bottom-up market neutral strategies.

However, hit by the current vagaries of the market, he has recently changed his tune somewhat. “The sharp rebound has already run its course but there appear to be some opportunities in direct lending and distressed strategies that are suffering in this environment of low credit creation. We also recognise the looming maturities that are on everyone’s radar. That may present a great opportunity for distressed strategies,” he revealed.

Regardless of strategy, small firms have been left in the cold recently, as investors stick to comfortable ‘brand’ names. However, this is also shifting, as allocators look for better returns. Investing in these emerging managers is part of the natural evolution of hedge fund investing, says Molinari. “While new investors pursue well-known names, mature investors begin to consider the opportunities in the space,” he explains.

“Our studies show roughly the same number of small and large funds reporting for each year’s study, and
additional industry research shows that survivor rates aren’t significantly different for emerging managers than for established managers,” says Molinari.

However, smaller managers continue to have a difficult time of it, especially in the past two years, as the industry has seen a ‘flight to quality’ with larger well-known funds perceived as high quality/less risk firms.

Lately, investors have been focused on liquidity, operations and transparency – issues that smaller funds aren’t always able to satisfy. Partridge is doubtful about investing SDCERA’s assets with emerging managers in the current climate. “It’s unlikely given the environment we are in and the emphasis on operational due diligence,” he said.

So it comes as no surprise that HFR recently reported that nearly all of the $23bn in net inflows into hedge funds during the first half of 2010 went into funds with $5bn or more.

Yet, there is still room for the smaller funds out there, and new emerging manager programmes have been kicking off all over the US, from the $132bn New York State Common Retirement Fund to the $21bn Texas Employees Retirement System. Winning investment may still be something of a street-fight, but if the performance and risk management are right, there are mandates out there to suit everyone.