Hedge funds started 2017 under pressure and the overall industry’s model was in question. Performance and fees were the main topic of debate among investors at the beginning of the year, but hedge funds managed to pull a strong year with no down month. Despite losses from some large managers, the industry overall generated strong returns according to HFR data attracting more capital. Per HFR, total hedge fund industry AuM increased by $59bn to $3.21tr, the sixth consecutive quarterly record for total industry AuM. The inflows suggest a sign of regained optimism, but the industry will need to sustain its performance long-term in order to regain its calibre. The oxymoron of the industry is the fact that equity hedge were the best performing strategies amongst hedge funds but suffered the biggest outflows. Macro, CTAs and multi-strategy attracted more capital this year, and given the outlook for more volatility and less central bank intervention, investors target further allocations in those sub-sectors.
2017 was the year producing the strongest return for hedge funds since 2013 and second best since 2009. Stone Mountain Capital strategies outperformed in last year’s environment across all asset classes. Credit was the only strategy underperforming its peers, caused by yield compression in the direct lending space. One, out of only three negative strategies was in credit, while the other two, were CTAs that struggled amid the low volatility and trendless environment. Despite these two strategies, tactical trading was overall the best performing strategy with strong returns generated by discretionary global macro and cryptocurrency. Equities enjoyed a very profitable year and Stone Mountain Capital’s mandated equity hedge managers produced astonishing returns, beating their traditional and alternative peers. Finally, fund of hedge funds recovered from their 2016 losses, surviving while the industry’s model is evolving.
Private debt continued its fundraising momentum in 2017 seeking to capitalise on investors’ search for uncorrelated sources of income. It was a record year for commitments in the asset class according to Pitchbook, a fact that highlights the increased competition in the space. This competition subsequently led to yield compression and more covenant lite lending agreements. Manager selection and due diligence becomes crucial amid this heated market, where deal flow is increased and the quality of deals deteriorated. The Alternative Credit Council projects the asset class to reach $1trilling from $630bn currently until 2020. The interest in the space is caused by the compression in the liquid credit markets, which urges investors to explore the private credit spectrum, with focus on floating-rate strategies like US CLOs and direct lending. Investors seek to harvest complexity, illiquidity and regulatory premiums in private credit, whilst keeping its low volatility profile. Investors target mainly mezzanine, direct lending and distressed debt in their search for yield.
The investors’ appetite for private equity continued last year bringing the dry powder in the asset class to record levels. Closing larger funds takes less time than usual, but the challenge remains the identification of good investment opportunities and deal sourcing. High valuations and exit environment were the challenges in 2017 and remain for the year to come. In 2017, almost 1,700 companies went public, a large increase since 2016. This year, investors would look into niche private equity funds investing in unique sectors that generate premiums not available in public markets. Direct competition from investors increased the entry prices and last year shaped a risky environment with huge sum of dry powder, slowing down exit activity and high valuations. Approximately 4,200 private equity deals were completed in 2017 reflecting capital of $347bn according to Preqin. The political environment seemed to stabilise in 2017, with concerns remaining about the terms of Brexit. This helped private equity firms raise record-level capital of $453bn during 2017.
2017 was a year of records for real estate equally. Urbanisation, co-living and co-working, and increased use of technology were the main themes last year and we expect those to continue in 2018. Almost 5,200 transactions were completed in 2017, while the asset class saw their assets, number of funds and dry powder reaching record levels. Brexit caused turbulences in the UK and European market, with other major hubs like Frankfurt, Paris and Dublin exploiting the new environment. Interest rates, deal flow and valuations were the main challenges last year and the increased number of funds made manager selection tougher.
2017 was the breakout year for crypto currencies and attracted a lot of attention among institutions. Ripple, a new solution for bank payment, was the biggest winner among its peers and the 2 major cryptocurrencies, according to market cap, Bitcoin and Ethereum also generated astonishing but volatile returns. Last year, we evidenced a lot of regulatory events in an attempt to better regulate the asset class particularly in Asia. During the summer, China shut down currency exchanges and later on banned ICOs. The SEC rejected the first Bitcoin ETF application but is reviewing a plethora of other related instruments. On the other hand, countries like Russia, India, Japan and Switzerland seem to be accepting the use of Bitcoin for transactions including regulatory frameworks. The most recent evolvement of the asset class was the launch of future contracts, which will allow for better price discovery, less volatility, shorting and better regulation. The institutionalisation of the asset class is boosting the capitalisation growth of the market, which currently stands at $551bn. Bitcoin experienced huge volatility movements, starting from less than $1,000, jumping to $20,000 before retreating to around $10,000. Ethereum also experienced a large increase in its value, as it started the year trading at $10 and currently is trading at nearly $1,150. 2018 could be a year to determine the future of the market and we expect institutional money to flow in the asset class for the first time.
The views expressed in this article are those of the authors and do not necessarily represent the views of, and should not be attributed to, Stone Mountain Capital LTD. Readers should refer to the Disclaimer.
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