​Hedge Funds
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.

STONE MOUNTAIN CAPITAL RESEARCH PERSPECTIVE VOL.63

The current market environment is characterised by high valuations in equities and low yields in traditional fixed income markets, urging investors to seek for alternative, diversified and stronger sources of return. Private debt is on its way to becoming an established asset class and falls under fixed income and private equity allocations of institutional investors. There is a broad set of opportunities within the private debt spectrum that spans from investment grade assets (IG CLOs, real assets and real estate senior debt) by lending across capital structure in mezzanine, to equity and first-loss like assets (distressed debt, CLO equity/warehousing/risk retention), depending on the risk-return profile of the institution. Navigating from the investment grade to high yield strategies (direct lending, capital relief trades, distressed debt and special situations) investors identify diversified sources of yield generated from illiquidity, complexity and regulatory premia. The $600bn private debt industry is set to exceed $1 trillion according to a research paper from the Alternative Credit Council. 

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The hedge fund industry is recuperating after two years of struggle. During the first half of 2017 hedge funds lived up to their investors’ expectations, who are looking to increase their hedge fund exposure for diversification and risk-return enhancement. The industry approximates $3.2 trillion in assets under management (AuM) across all strategies according to BarclayHedge with over five thousand institutional investors eyeing on the space of over 15,000 hedge fund strategies globally. Those numbers suggest an overcrowded space and considering data from the Asset Management Association of China, managers in China reach 25,000, the industry is in need of more regulatory attention.
Active management is again in demand and hedge funds will have to compete with their peers to attract more assets and it will be worthy to observe the fundraising arena. Using data from BarclayHedge for five main core strategies AUM, we observe that the main investor focus is on equity hedge (long/short, long-only and market neutral) and fixed income strategies, which are accounting for 25% and 18% respectively of hedge fund AuM. Macro and CTA strategies with $600bn account for 18%, while event-driven strategies are occupying only 5% of the industry’s AuM.

The new era of presidency in the U.S. is marked with significant changes, with the Treasury Secretary announcing tax reforms in the next six months and the FED ready to increase rates. Hedge funds have momentum and they extended their January gains into February, with CTAs posting the biggest returns according to HFRX index. Equity hedge, macro and event-driven strategies exhibited similar robust performance and proving that they overcame last year’s underperformance and they gaze into the future with confidence. A Preqin survey evidence a large increase in the number of alternative investors and the performance of alternative asset classes is encouraging for the future of the industry. In debt markets, the risk retention regime leads to lower volumes in CLO issuance and fewer deals. There is an increasing appetite for private debt strategies and the economic outlook may suggest a growth in commitments over the next two years. There are more funds focusing on European credit, which is indicative of the opportunities in the space amid a relatively uncertain political scenery. Private equity fundraising continues in solid pace, while competition for deals is increasing rapidly alongside the number of funds in the market. Adding hedge funds, that compete for similar deals, makes the identification of opportunities even harder. Both private debt and equity strategies focus on the mid-market spectrum as the opportunities there are more attractive. The same scenery prevails in real estate industry with high prices and increased competition being the main feature. The investment activity slowed down and the macro outlook with interest rate growth expectations and political uncertainty are the most significant drivers behind the slowdown.