The hedge fund industry has been experiencing a consolidation trend for many years now. However, in contrast to the past few years, never was it as pronounced as in 2023. In fundraising terms, smaller hedge funds struggled to raise sufficient capital throughout 2023, while large hedge fund managers saw huge inflows and even extended their offered funds. This effect was especially notable as the industry saw redemptions of a total of $280bn in 2023, as shown in Figure 1. When separating inflows into top-ups and new investments, top-ups dominated over the past three years, which again highlights the strength of established and emerging managers. In 2023, most established managers also were able to generate solid double-digit returns for investors, which is certainly appealing to investors. It is somewhat surprising that there is such a strong tendency towards large and established managers, as it is widely known that these managers charge (substantially) higher fees than other funds. 2023 was also an extreme year in terms of fees, as some of the largest managers keep more than 50% of the gains for themselves and the remainder flows to the investors. This emphasizes the strong preference of investors towards established managers. The reputation and the “proven skill” of these managers provide investors with a certain degree of “safety” when investing in hedge funds.
2023 followed the core theme of 2022 with a key focus on inflation and interest rates. At the beginning of 2023, inflation was a huge concern, due to its high level. In the US, inflation was at 6.5% and already declined substantially from its peak in June 2022 at 9.1%. This trend continued in 2023 until it reached its bottom in June 2023 at 3%. Since then, US inflation remained steady between 3% and 4%. The EU and the UK saw a very similar development of inflation throughout 2022. Their respective inflation started at around 5.5% in January 2022 and rose to 10.5% by the end of 2022. As soon as 2023 started, inflation in the EU started to decline and eventually declined to as low as 3.1% in November 2023. Despite this promising development, inflation began to increase again to 3.4% in December 2023. While the UK’s inflation development was almost equivalent to the EU’s in 2022, this changed in 2023. Inflation in the UK remained above 10% until April 2023, at which point inflation was at 10% or higher for almost an entire year. Nonetheless, UK inflation also came down later in 2023 and reached the 4% mark at the end of December 2023. Based on the overall relatively similar development of inflation around the world, it is likely that inflation will stay at elevated levels in the short term. Another key reason for relatively stale inflation is that central banks stopped hiking their interest rate for a while now in 2023. Figure 1 summarizes the development of inflation in the US, EU, and the UK.
With the soaring inflation in 2021 and afterward, central banks had to react. Financial markets enjoyed rates close to zero, if not negative, for a long time. As a response, central banks started raising their interest rates. The Bank of England was the first to raise its interest rates in December 2021. The Fed followed in March 2022 and hiked its rate in every meeting and by a higher amount on average than the BoE or the ECB. The BoE did so too, but did smaller hikes on average. The ECB followed in June 2022, but they did not hike at every meeting. At the start of 2023, the interest rate in the US was already at 4.25% compared to 3.5% in the UK and 2.5% in the EU. Consequentially, the ECB hiked more in 2023 but did not reach the same heights as in the US or UK, which are currently at 5.25%, while the ECB’s interest rate remains at 4.5%. With interest rates now higher than inflation rates in each of those economies, most market participants expect interest rate cuts in 2024, especially due to an elevated possibility of a recession ahead.
The cryptocurrency industry starts in 2024 with a massive win. The SEC approved multiple spot Bitcoin ETFs on Wednesday (10th January 2024). This is a major development of the industry’s adaptation to the broad financial markets and institutional investors in particular. While there were already multiple relevant ways to obtain crypto, e.g. through mutual funds, Bitcoin Futures ETFs, and Grayscale’s Bitcoin Investment Trust, it brings more regulatory clarity to the industry, which is still an important issue and prevents some investors from entering the space. This could also open the door for further crypto ETFs, such as Ethereum ETFs, in the future. However, the SEC clearly stated this approval does not constitute an opinion on cryptocurrencies as a whole or any individual tokens, which remain largely considered investment contracts that fall under the federal securities law.
This development is especially notable, due to the amount of time it took. In 2013, the Winklevoss twins filed for a Spot Bitcoin ETF, which was denied in 2017. Many other ETF providers filed for approval during the following years, which were also declined. In August 2021, the Chair of the SEC mentioned that they would look favourably on ETFs based on Bitcoin Futures instead of spot Bitcoin, largely due to the underlying regulatory clarity futures provide over cryptocurrencies. Following this development, the first Bitcoin Future ETFs were approved in October 2021. Then in 2022, Grayscale Investment filed for a potential conversion of the Bitcoin Trust to an ETF, which the SEC declined. Following this decision, Grayscale sued the SEC for their “arbitrary and capricious” explanation. In August 2023, judges ruled in favour of Grayscale, which led to increasing optimism on spot Bitcoin approvals and the eventual approval in 2024.
Inflation and interest rates have been present topics. Inflation rates have continuously decreased throughout 2023 across most economies. While this development was promising, it was necessary as inflation rates went as high as almost 12% towards the end of 2022. In the US, inflation has decreased to 3%-4% in the past few months with no particular direction since then. For 2024, it is widely expected that inflation will decrease further, albeit to a limited degree. Most market participants expect inflation to be around 2.3% by the end of 2024. Others see inflation to drop to as low as 1.6%. Assuming no further geopolitical crises and no further escalation of existing crises, inflation is unlikely to rise further than 3.5% by the end of 2024. Figure 1 shows the development of inflation rates in the US, UK, and the EU from January 2022 to the end of 2024. The general sentiment that inflation rates should fall is intuitive given the high interest rates at this time. In the EU, the development has mostly mimicked the US, but with a delay of a couple of months, due to a more restrictive central bank policy when Covid-19 emerged. Inflation in the EU has also reached a point, where inflation is no longer declining at levels slightly below 4% after being at 10% at the beginning of the year. For 2024, inflation is also expected to further fall, but not to the same degree as in the US. Expectations for inflation in the EU range from 2.6% to 4.5% with the most likely level around 3.4%. The situation in the UK also drastically improved towards the end of the year. UK’s inflation fell to 4% after lingering around the 10% mark for almost an entire year. Inflation expectations for the UK are mostly equivalent to the EU’s expectations, but its projections are more volatile based on the country’s state over the past few years.