Hedge fund assets shrink as performance dispersion, opportunities grow

Hedge funds just saw their largest quarterly outflows since investors redeemed in the second quarter of 2009, but is more pain yet to come?

HFR reported that hedge fund industry assets fell back below $3 trillion at the end of first quarter of 2020 with a decline of $366 billion of which $33 billion was in investor outflows with the remaining $333 billion being performance-based losses.

The figures are surprising but with large and popular hedge funds of all strategy types have experienced severe downturns thanks to the economic fallout coming out of the global COVID-19 pandemic.

“While volatility and market dynamics remain fluid through early 2Q, dislocations created by indiscriminate selling from traditional asset management have created significant opportunities for specialized long/short funds, which are likely to benefit both forward-looking funds and institutional investors in coming quarters,” said Kenneth Heinz, president of HFR.

Performance losses were led by event-driven strategies, according to HFR, as the free fall of equity markets and widening deal spreads forced the managers housed in the HFRI Event-Driven Index to a first quarter loss of -15.3% of which -12.7% occurred in March alone.

Macro strategies were up slightly for the quarter, the HFRI Macro index was up 0.07% in the first quarter after logging a gain of 1% in March.

Macro funds such as the Haidar Jupiter Fund are up a whopping 51.18% in the first quarter though as March yielded gains of more than 20%.

Pure trend-following strategies were one of the standout performances in March, according to UK-based consulting firm bfinance. Officials there say that bond exposures were particularly helpful as treasury yield curves tightened. Also, modest net-short positions in equities helped with many CTA managers scaling back long-equity exposures through February and March.

Yet, investors also redeemed $22 billion primarily in quantitative trend-following CTA strategies, according to HFR.

Numerous strategies were challenged in the second half of March with widespread de-risking resulting in further downward price pressure that was coupled with heightened illiquidity and extremely wide bid/ask spreads, said the team at bfinance. They point out that the spreads in usually highly liquid instruments in fixed income and currency markets were under particular pressure in March as much of the month was dominated by a liquidity crisis due to the economic impact of COVID-19.

By comparison, equity-oriented hedge funds have never seen such performance dispersion thanks to the market rout.

For instance, the Odey European Fund managed by Crispin Odey was up 20.98% in March, while other funds such as Lee Ainslie’s Maverick Fund was down -12.44%.

According to bfinance, elevated volatility and significant dispersion should provide ample opportunities for equity long/short strategies, especially ‘double alpha’ strategies that seek to add value from both the long and short books.

An area of probable large-scale investor interest is distressed debt, which saw record levels of capital being raised currently in recent weeks. Many expect interest in alternative credit and distressed debt to continue to soar no matter what the stock market does.

One of the largest new funds raised was Oaktree Capital’s $15 billion distressed debt fund that is the most notable among a number of high profile launches in the space.

“One of the greatest uncertainties we face today surrounds the outlook for the economy,” Oaktree founder Howard Marks wrote of the current global coronavirus pandemic. “The optimists expect a V-shaped recovery, and a great deal is riding on the question of whether it’ll materialize. It depends on when America will go back to work, and that, in turn, depends to a great extent on the trend in infections.”

Pimco is reportedly raising yet another $3 billion distressed debt fund right now counting Fresno County Employees’ Retirement Association among its potential investors, according to a report from Bloomberg.

Meanwhile at Blackstone, the firm’s GSO business reported losses of -30% in the first quarter, which brought returns for the year ending March 31 to -35.3%. The losses were disclosed in the company’s first quarter earnings report.

Yet so far in 2020, the firm has reported $2.5 billion in inflows in its $132 billion credit and insurance unit and is holding on to roughly $28 billion in dry powder it has yet to put to work in the space.

Looking forward there are likely to be opportunities to deploy capital into stressed/distressed restructuring opportunities as businesses continue to face headwinds from the current environment, according to bfinance. Within the M&A space, consultants expect strategically important deals to continue and anticipate potentially higher activity from private market capital seeking opportunistic deals.

Ultimately though, the hedge fund industry’s future prospects are to be aligned with the investor’s patience in seeking diversified opportunities.

According to a recent bfinance poll of 260 investors, a significant minority have not been satisfied with the performance of liquid alternative strategies including hedge funds in the first quarter. Investors and asset managers must now rely on contemporaneous empirical results to improve their understanding of liquid alternative strategies, rather than relying on previously assumed knowledge or past experiences.

As with 2008, it is highly likely this will result in changes to investment philosophies, processes, and portfolio allocations, officials said.

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