investing in hedge funds: all about returns? · diversifi cation of risk premia, and absolute...
TRANSCRIPT
Content Includes:
Why Should Institutions Invest in Hedge Funds?
What is leading investors to increase their allocations to hedge funds? How can hedge funds add to investors’ portfolios?
What Are Institutions Looking for from Hedge Funds?
We examine what investors look for from their hedge fund investments, particularly in terms of absolute and risk-adjusted returns, as well as how they plan to invest in the future.
Have Hedge Funds Lived Up to Expectations?
How satisfied are investors with the returns hedge funds provide? Do they meet expectations over shorter and longer time frames?
How Should Institutions Benchmark Performance?
With over 16,000 hedge funds to choose from, how should investors monitor the funds in their portfolio against the wider performance of the industry?
Investing in Hedge Funds: All About Returns?
The Real Drivers for Institutional Investor Allocation
June 2014
alternative assets. intelligent data.
2
Investing in Hedge Funds: All About Returns?
© 2014 Preqin Ltd. / www.preqin.com
Download the data pack:www.preqin.com/HFJun14
Foreword
Since 2007, Preqin has been tracking institutional investment in hedge funds. Our teams of analysts based in London, New York and Singapore have tens of thousands of conversations with investors each year to give us a unique insight into the minds and portfolios of the institutional groups which have driven the industry to its current $2.66tn in assets.
Despite a new global regulatory framework which has resulted in increased regulatory transparency, and the vote of confi dence from institutional investors worldwide who use hedge funds to diversify their return streams, the industry is still viewed as largely opaque, complex, risky, and lightly regulated by the general public and the media. With the largest investors, such as pension funds, insurance companies and sovereign wealth funds, guarding the assets of the typical member of the public, it is important to shine a light on why these gatekeepers have turned to hedge fund investment in recent years, and how these hedge funds are safeguarding assets for the future.
In this report we examine why investors are allocating their capital to hedge funds, what they seek from the funds they invest in and how they assess the success of their portfolio. With much of the criticism hedge funds have faced over recent years focusing on their relative performance to S&P 500, we look at how funds have actually performed and met investors’ return expectations for risk-adjusted returns in all market conditions, as well as taking a closer look at why S&P 500 is becoming a less relevant benchmark for the industry. Central to our examination is an understanding that the hedge fund industry is not monolithic, but populated by a diversity of strategies with differing investment goals and return assumptions. This premise is often ignored or not understood by critics of hedge fund performance.
In this report we answer the following questions:
• Who is investing in hedge funds?• Why should institutional investors allocate to hedge funds?• What absolute and risk-adjusted returns are investors seeking from hedge funds?• How has the industry met the return objectives for investors?• How should investors frame the performance of their portfolios?
The results of this study are based on a survey of over 100 investors conducted in April this year, with these investors representing more than $13tn in assets under management. The investors were located globally and represented a broad spectrum of investor types from the largest pension funds, through to family offi ces and other private wealth institutions. Additional data has been taken from our Hedge Fund Online service, a fully integrated solution providing key information on over 4,600 investors in hedge funds, 16,500 hedge funds and 6,700 fund managers. Preqin’s Hedge Fund Online service provides intelligence on institutional plans for hedge fund investment as well as full portfolio details, and looks at how the industry is performing with data on a fund-by-fund basis.
We hope you fi nd this report useful, and welcome any feedback you may have. For more information, please visit www.preqin.com or contact [email protected].
All rights reserved. The entire contents of Investing in Hedge Funds: All About Returns?, June 2014 are the Copyright of Preqin Ltd. No part of this publication or any information contained in it may be copied, transmitted by any electronic means, or stored in any electronic or other data storage medium, or printed or published in any document, report or publication, without the express prior written approval of Preqin Ltd. The information presented in Investing in Hedge Funds: All About Returns?, June 2014 is for information purposes only and does not constitute and should not be construed as a solicitation or other offer, or recommendation to acquire or dispose of any investment or to engage in any other transaction, or as advice of any nature whatsoever. If the reader seeks advice rather than information then he should seek an independent fi nancial advisor and hereby agrees that he will not hold Preqin Ltd. responsible in law or equity for any decisions of whatever nature the reader makes or refrains from making following its use of Investing in Hedge Funds: All About Returns?, June 2014.
While reasonable efforts have been made to obtain information from sources that are believed to be accurate, and to confi rm the accuracy of such information wherever possible, Preqin Ltd. does not make any representation or warranty that the information or opinions contained in Investing in Hedge Funds: All About Returns?, June 2014 are accurate, reliable, up-to-date or complete. Although every reasonable effort has been made to ensure the accuracy of this publication Pre-qin Ltd. does not accept any responsibility for any errors or omissions within Investing in Hedge Funds: All About Returns?, June 2014 or for any expense or other loss alleged to have arisen in any way with a reader’s use of this publication.
Data Source:
Preqin’s Hedge Fund Online provides a comprehensive view of the hedge fund industry, including:
• In-depth profi les of over 16,500 hedge funds and 6,700 hedge fund managers• Detailed performance metrics on over 9,600 hedge funds and share classes• Extensive information on over 4,600 active investors in hedge funds• Fund-by-fund and industry level fund terms and conditions data for over 6,200 hedge funds
For more information on how Preqin’s hedge fund data can help you, or to arrange a demonstration, please visit:
www.preqin.com/hedge
Investing in Hedge Funds: All About Returns?Download the data pack:www.preqin.com/HFJun14
3 © 2014 Preqin Ltd. / www.preqin.com
Executive Summary
Our fi ndings offer a valuable insight into the mindset and goals of institutional investors who decide to add hedge fund allocations to their portfolios. Our fi ndings demonstrate that the frequent, broad comparisons of hedge fund performance to standard market indices, such as the S&P 500, are generally viewed as irrelevant by the institutions making the investments and judging their
success. Rather, the survey responses point to reduced volatility, diversifi cation of risk premia, and absolute returns as the leading objectives of the global institutional investors making hedge fund allocations.
Who Is Investing in Hedge Funds?
65%of hedge fundindustry capitalcomes frominstitutionalinvestors
4,600+institutional investorsallocate capital to
hedge funds
US54%
Europe27%Middle East
5%
Asia7%
Proportionof industrycapitalinvested byinstitutionsby regional HQ
87%of investors are maintaining or increasing their allocations in the next 12 months
87%
What Are Investors Looking for From Hedge Funds?
How Are Hedge Funds Performing?
How Do Investors Benchmark Returns?
59% seek uncorrelated returns
56%
46%
7%
seek risk-adjusted returns
to reduce portfolio volatility
...just 7% for high returns
84%of investors feel return
expectations have been met or exceeded in the past 12 months.
80%of investors believe portfolio risk would increase if they ceased
investing in hedge funds
1/5S&P 500 and other public indices are commonly seen as irrelevant
– just a fifth compare hedge funds to these benchmarks.
Investors are commonly using strategy-specific hedge fund indices to measure portfolio
performance.
Canada 4%
• View all hedge funds currently open for investment
• Track fund-level past performance for managers with a fund open for investment
• Connect with fund managers
• Benchmark terms and conditions by fund strategy, geographic location and fund size
• Access valuable market analysis and performance benchmarking research
Preqin Investor Network focuses exclusively on helping investors make alternative asset allocation and investment decisions, and is already used by over 6,000 investment professionals. Use the Investor Network to:
Investor Network
Compare. Connect. Invest.
Signing up to Preqin Investor Network is easy – to register for free, please visit:
New York+1 212 350 0100
London+44 (0)20 7645 8888
Singapore+65 6305 2200
San Francisco+1 415 835 9455
www.preqin.com/pin
Identify and evaluate hedge fund investment opportunities on Preqin Investor Network.
Investing in Hedge Funds: All About Returns?Download the data pack:www.preqin.com/HFJun14
5 © 2014 Preqin Ltd. / www.preqin.com
Who Invests in Hedge Funds?
As shown in Fig. 1, there are a wide variety of institutional investor types allocating capital to hedge funds today. Each year there are more and more investors making maiden allocations to the asset class, and today Preqin currently tracks over 4,600 separate institutional groups active in the space.
Although there are institutional investors investing in hedge funds globally, over half of the assets invested by institutional investors are directed to these funds from investors based in the US (Fig. 2). Alongside the US, European investors have signifi cant amounts of capital invested in hedge funds, with regions such as Asia, Australasia and the Middle East investing smaller amounts. However, these regions will become an increasingly important source of assets in the future as more institutions in these emerging regions realise the benefi ts of hedge funds and local regulatory changes open up opportunities for investing in alternatives.
Fig. 3 shows the average allocation (as a proportion of total assets) of various institutional investor types to hedge funds from December 2012 through to April 2014. It is clear that all groups, except insurance companies, have increased their allocations over this period. In fact, if the data is taken back even further the same pattern emerges; investors are not only making maiden investments in hedge funds, they are also increasing the amount they invest in the asset class year on year.
19%
15%
15%12%
9%
8%
7%
4%4%
2%1%
1%1%1%1%
Foundation
Fund of Hedge FundsManagerPrivate Sector PensionFundEndowment Plan
Public Pension FundWealth Manager
Family Office
Asset Manager
Insurance Company
Superannuation SchemeInvestment Company
Bank
Corporate InvestorSovereign Wealth FundOther
Fig. 1: Breakdown of Investors in Hedge Funds by Investor Type
Source: Preqin Hedge Fund Investor Profi les
54%
27%
7%
5%4%
2%0.3%
0.1%
US
Europe
Asia
Middle East
Canada
Australasia
Africa
Central and SouthAmerica
Fig. 2: Breakdown of Institutional Investor Capital Invested in Hedge Funds by Investor Regional Headquarters (Excl. Funds of Hedge Funds)
Source: Preqin Hedge Fund Investor Profi les
The hedge fund industry is larger than ever, with over $2.66tn in assets managed across 16,000 vehicles worldwide. This growth has been driven by increased commitments from institutional allocators as they seek alternatives to traditional investment in equity and fi xed income products. In this section we examine the current make-up of the institutional universe for hedge fund investment, using data taken from Preqin’s Hedge Fund Investor Profi les online service.
18.7% 16.6% 16.6%
2.3%
9.3%
6.9% 6.6%
18.9% 19.5%17.5%
2.5%
9.9%
7.5% 6.9%
19.0% 20.3%17.6%
2.3%
10.5%
7.7% 7.0%
0%
5%
10%
15%
20%
25%
End
ow
me
nt
Fam
ilyO
ffic
e
Fou
nd
atio
n
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ran
ce
Co
mp
an
y
Priv
ate
Se
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en
sion
Fu
nd
Pu
blic
Pe
nsio
n F
un
d
Sove
reig
nW
ea
lth F
un
d
2012
2013
2014*
Fig. 3: Mean Allocation to Hedge Funds by Investor Type, 2011 - 2014*
Source: Preqin Hedge Fund Investor Profi les
Me
an
Allo
ca
tion
*As of April 2014, all other fi gures are at December.
In Brief A wide range of investors allocate capital to
hedge funds.
Although the US is the largest source of institutional capital, hedge funds are important to investors globally.
We have seen investors increase the amount they invest in hedge funds over recent years.
6
Investing in Hedge Funds: All About Returns?
© 2014 Preqin Ltd. / www.preqin.com
Download the data pack:www.preqin.com/HFJun14
Why Should Institutions Invest inHedge Funds?
It is clear that investors are looking to hedge funds to perform a variety of functions – from producing uncorrelated returns through to risk mitigation (Fig. 4). However, producing high returns, a perception many outside of the industry believe is the domain of the hedge fund, is a priority for just a small proportion (7%) of the investors that participated in Preqin’s survey. When investors were questioned further about what their single reason for recommending hedge funds would be, three key benefi ts came out time and time again – to reduce volatility, diversify risk premia, and produce absolute returns.
Alongside these reasons, many of the investors interviewed would recommend investing in hedge funds on the basis of the chance to tap into talented individuals, with one North American family offi ce responding “we, as investors, are given the opportunity to align ourselves with some of the smartest guys in the world, who are attracted to this space due to high potential incentive fee generation”. However, this potential incentive fee generation is a cause for concern for many investors, with 22% of the investors that participated in Preqin’s study stating that fees are their single largest impediment to investing in hedge funds (Fig. 5).
Nevertheless, fees have come down over recent years with the “2&20” model no longer being the accepted standard, and fund managers are more open to negotiation than they were in the pre-crisis era. Therefore, investors may be able to overcome this hurdle through pre-investment screening and negotiations.
The complexity of the industry and the diffi culty in sourcing the right funds both act as barriers for a large number of investors. However, investors are becoming more proactive in sourcing and selecting hedge funds. Tools such as Preqin Investor Network are helping these increasingly sophisticated groups of institutions to navigate the complex alternative assets market and connect with the right investment manager for them.
Re
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at
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co
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late
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uity
Ma
rke
ts
Pro
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ce
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solu
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etu
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in A
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ets
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e R
ob
ust
Risk
-Ad
just
ed
Re
turn
s
To D
am
pe
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ort
folio
Vo
latil
ity
To D
ive
rsify
To
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To M
itig
ate
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er A
rea
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l Po
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To D
ive
rsify
Alte
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et
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Hig
h R
etu
rns
Re
turn
s th
at
Are
Co
rre
late
d t
oEq
uity
Ma
rke
ts
Oth
er
59%54% 53%
46% 45%
30%
19%
7%2% 4%
0%
10%
20%
30%
40%
50%
60%
70%
Fig. 4: Key Objectives of Institutional Investors From Their Hedge Fund Portfolios
Source: Preqin Investor Survey, April 2014
Pro
po
rtio
n o
f R
esp
on
de
nts
23%
22%
21%
14%
8%
6%6%
Difficult to Source GoodFunds
Cost - Fees
Complexity of theIndustryPerformance of theIndustry Is Not GoodEnough
Public Sentiment isNegative Towards theAsset Class
Cost - AdditionalInternal Resource
Our Board Is NegativeTowards the Asset Class
Fig. 5: Single Largest Impediment to Investing in Hedge Funds
Source: Preqin Investor Survey, April 2014
Preqin currently estimates that institutional capital could account for as much as 65% of the $2.66tn of capital managed in the hedge fund industry today. What is leading these investors to increase their allocations to hedge funds, moving these types of investments from an alternative in their portfolio to a mainstream investment option?
31%
21%
21%
41%
38%
30%
28%
40%
44%
1%
2%
5%
0% 20% 40% 60% 80% 100%
12 Months
3 Years
5 Years
Hedge FundsHave Met All ofThese Objectives
Hedge FundsHave Met Mostof TheseObjectives
Hedge FundsHave Met Someof TheseObjectives
Hedge FundsHave Met Noneof TheseObjectives
Fig. 6: Investor Outlook on How Hedge Funds Have Met Key Objectives over a 12-Month, 3-Year and 5-Year Period
Source: Preqin Investor Survey, April 2014Proportion of Respondents
In Brief It is uncorrelated and risk adjusted returns rather
than high returns institutional investors seek.
Hedge funds have largely met these objectives over recent years
Investors need help sourcing the right hedge fund investment opportunities.
Investing in Hedge Funds: All About Returns?Download the data pack:www.preqin.com/HFJun14
7 © 2014 Preqin Ltd. / www.preqin.com
What Are Institutions Looking ForFrom Hedge Funds?
As shown in Fig. 7, for most of the investors that participated in this study the absolute annualized returns sought are relatively modest. Two-thirds of the investors that participated stated they seek returns between 4% and 6% per annum. Just 6% of investors look for their portfolios of funds to add more than 10% each year, confi rming the fi ndings in the previous section that only a few investors, just 7%, stated that they choose to invest in hedge funds as a result of their high returns expectations. In regards to volatility and risk expectations, 95% of the investors interviewed stated they had created portfolios of funds designed to exhibit lower volatility than equity markets (Fig. 14). The combination of reduced volatility and reduced risk is important to investors. As one wealth manager, with more than 60% of its assets invested in hedge funds, put it, “If you are attempting to reduce volatility and improve the quality of your returns, you need hedge funds”.
Although hedge funds are seen as a relatively liquid alternative asset, most investors see the industry as a long-term investment solution within their portfolio. The investment when committing to hedge funds is calculated in more than just the amount invested in the fund; creating a portfolio of funds to meet a particular set of risk/return requirements takes time by both the investors and
their consultant to assess the opportunities in the market, source compatible funds and carry out due diligence on the potential vehicles. Additionally, once an investment is made and a portfolio is created, ongoing monitoring and management are also both resource intensive. As a result most institutional investors, once they have set up their hedge fund program, are committed to investing in hedge funds for long periods of time. As shown in Fig. 8, the most common time frame over which investors measure the success of their portfolio is three years; however, signifi cant proportions of investors, 29% and 15% of respondents respectively, look at their portfolio success over fi ve- and ten-year periods.
3%
0%
5%
15%
26%
30%
11%
2%3%
0%
3% 3%
0%
5%
10%
15%
20%
25%
30%
35%
0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% Morethan10%
Fig. 7: Absolute Returns Sought by Institutional Investors from their Hedge Fund Portfolios
Source: Preqin Investor Survey, April 2014
Annualized Absolute Return
Pro
po
rtio
n o
f R
esp
on
de
nts
As shown, investors are looking at hedge funds to do more than produce high returns; in fact it is their ability to produce risk-adjusted absolute returns which are uncorrelated to equity markets that appeals to these institutions. In this section we look at what the precise requirements of investors from their hedge funds in their portfolio are, both in terms of the absolute returns generated, as well as over what time frames they judge the success of their portfolio.
5%
24%
14%
50%
29%
15%
4%
0%
10%
20%
30%
40%
50%
60%
Less
th
an
12
Mo
nth
s
12 M
on
ths
2 Y
ea
rs
3 Y
ea
rs
5 Y
ea
rs
10 Y
ea
rs
Lon
ge
r th
an
10 Y
ea
rs
Fig. 8: Time Frame(s) Against Which Institutional Investors Measure the Success of their Portfolio
Source: Preqin Investor Survey, April 2014Time Frame Success Is Measured Against
Pro
po
rtio
n o
f R
esp
on
de
nts
In Brief 67% of investors seek annualized returns
between 4% and 6%.
Investors look for hedge funds to produce returns with lower volatility than equity markets.
Institutional investors are committed to investing in hedge funds for long periods of time.
Data Source:
Hedge Fund Investor Profi les tracks 4,600 active hedge fund investors, and over 50 unique fi elds of data on each investor’s preferences, including their returns expectations, volatility appetite, and more. All information is collected directly from the source and our powerful advanced search helps managers target investors suitable for their funds. For more information, please visit:
www.preqin.com/hfip
8
Investing in Hedge Funds: All About Returns?
© 2014 Preqin Ltd. / www.preqin.com
Download the data pack:www.preqin.com/HFJun14
Have Hedge Funds Lived Up toInstitutional Expectations?
As shown in Fig. 9, the largest proportion of investors (84%) feel that over the past 12 months their returns expectations have been met or exceeded (measured to Q1 2014). This is the same level of satisfaction with returns as seen in the 12 months to the end of 2013 (as shown in the 2014 Preqin Global Hedge Fund Report), and represents the highest level of investor satisfaction with hedge fund performance since Preqin started recording this data. This will come as a relief to fund managers in the industry, which has had its worst start to the year since 2008.
As shown in Fig. 10, hedge fund performance in the past 12 months and over the longer fi ve-year period has matched the 4-6% requirements set by the majority of institutional investors. Over a three-year period, annualized returns of hedge funds failed to reach 6% (Fig. 10), largely caused by a problematic 2011. However, with only 22% of investors stating they seek returns of 6% or more (Fig. 7) and just 33% stating that their returns objectives had not been met in a three-year period (Fig. 9), even this relatively low level of annualized performance is seen as satisfactory by the bulk of investors.
In addition to hedge funds generally matching absolute return expectations, these funds have also managed to exhibit both lower volatility than equity markets (Fig. 11) and better risk-adjusted returns (Fig. 12) when measured against the S&P 500 over a three-year period. The S&P measurements are based on the month-end to month-end movement of the S&P 500, in order to compare to hedge funds data which is gathered monthly. As shown in Fig. 14, 95% of investors which participated in this study have designed their portfolios to exhibit less volatility than equity markets, so it is clear the industry is meeting this objective.
16%
31%
31%
62%
53%
50%
22%
13%
13%
0%
2%
6%
0% 20% 40% 60% 80% 100%
12 Months
3 Years
5 Years
Hedge FundReturns Did NotMeet Expectations
Hedge FundReturns MetExpectations
Hedge FundReturns ExceededExpectations
Have Not BeenInvesting Over ThisPeriod
Fig. 9: Proportion of Institutional Investors that State Hedge Fund Returns Have Lived Up to Expectations over a 12-Month, 3-Year and 5-Year Period
Source: Preqin Investor Survey, April 2014Proportion of Respondents
0%
5%
10%
15%
20%
25%
Ma
y-11
Jul-1
1
Sep
-11
No
v-11
Jan
-12
Ma
r-12
Ma
y-12
Jul-1
2
Sep
-12
No
v-12
Jan
-13
Ma
r-13
Ma
y-13
Jul-1
3
Sep
-13
No
v-13
Jan
-14
Ma
r-14
S&P 500
HedgeFunds
Fig. 11: Rolling Volatility of Hedge Funds vs. S&P 500, May 2011 - April 2014
Source: Preqin Hedge Fund Analyst
Thre
e-Y
ea
r Vo
latil
ity
Most investors look to hedge funds to add sources of consistent, low volatility mid-single digit returns to their portfolios. With investors looking at hedge funds over the short (12 months), medium (three years), and long (fi ve years) timeframes, we examine how hedge funds have met investors’ expectations outlined earlier in this report over these periods using data from Preqin’s Hedge Fund Analyst online service, and the results of our interviews with 100 institutional investors.
7.87%
11.53%
5.73%
11.74%
0%
2%
4%
6%
8%
10%
12%
14%
12 Months 2013 3-YearAnnualized
5-YearAnnualized
Fig. 10: Hedge Fund Returns (As at April 2014)
Source: Preqin Hedge Fund Analyst
Ne
t R
etu
rns
In Brief Investors are the most satisfied with returns they
have ever been.
Hedge funds are meeting investor expectations on an absolute and a risk-adjusted basis.
Investing in Hedge Funds: All About Returns?Download the data pack:www.preqin.com/HFJun14
9 © 2014 Preqin Ltd. / www.preqin.com
Fig. 13 depicts the lossmaking periods suffered by hedge funds and the S&P 500 during the last six years. The equities index has seen both more instances of drawdown and more severe drawdowns than hedge funds over the course of this period.
Thirty percent of investors stated that they use hedge funds to mitigate risks in other areas of their portfolio (Fig. 4). As shown, in Fig. 15 investors are largely confi dent that hedge funds are doing this; eighty percent of institutions believe that if they were to remove hedge funds from their portfolio the overall level of risk of their investments will increase.
One area where hedge funds may be failing to meet investor expectations is uncorrelated returns; the current correlation coeffi cient of hedge funds to S&P 500 is 0.69 when the index is positive and 0.72 when it is in negative territory. In the current bull market this has driven returns upwards; however, some investors
may be looking at other hedge fund strategies such as macro funds and CTAs to provide some downside protection for when the bull run ends.
Hedge Funds
Long/ShortEvent Driven
Relative ValueMacro
Multi-Strategy
S&P 500
0%
2%
4%
6%
8%
10%
12%
14%
0% 2% 4% 6% 8% 10% 12%
Fig. 12: Risk-Return Profile of Hedge Funds vs. S&P 500 (As at April 2014)
Source: Preqin Hedge Fund AnalystThree-Year Annualized Returns
Thre
e-Y
ea
r Vo
latil
ity
-50%
-45%
-40%
-35%
-30%
-25%
-20%
-15%
-10%
-5%
0%
Ma
y-08
Sep
-08
Jan
-09
Ma
y-09
Sep
-09
Jan
-10
Ma
y-10
Sep
-10
Jan
-11
Ma
y-11
Sep
-11
Jan
-12
Ma
y-12
Sep
-12
Jan
-13
Ma
y-13
Sep
-13
Jan
-14
S&P 500 Hedge Funds
Fig. 13: Drawdowns of Hedge Funds vs. S&P 500, May 2008 - April 2014
Source: Preqin Hedge Fund Analyst
Dra
wd
ow
n S
ize
95%
4%1% Portfolio Is Designed toHave Less Volatility thanEquities
Portfolio Is Designed toHave Similar Volatility toEquities
Portfolio Is Designed toHave More Volatilitythan Equities
Fig. 14: Investors Opinions’ on Hedge Fund Portfolio Volatility vs. Equity Volatility
Source: Preqin Investor Survey, April 2014
80%
11%
9% Removing HedgeFunds Would IncreaseRisks in Portfolio
Removing HedgeFunds Would DecreaseRisks in Portfolio
Unsure of the Effect ofRemoving HedgeFunds from Portfolio
Fig. 15: Investors’ Opinions on the Effect of Removing Hedge Funds from their Portfolio on Risk
Source: Preqin Investor Survey, April 2014
In Brief Most investors feel that if they were to cease
investing in hedge funds, the amount of risk in their portfolio would increase.
However, correlation to equity markets may be a concern for some investors.
10
Investing in Hedge Funds: All About Returns?
© 2014 Preqin Ltd. / www.preqin.com
Download the data pack:www.preqin.com/HFJun14
How Should InstitutionsBenchmark Performance?
Hedge fund investors use a variety of methods to benchmark their portfolios against the wider hedge fund industry (Fig. 16). The largest proportion of investors (36%) use separate benchmarks to compare the separate strategies in their hedge fund portfolios. The term “hedge fund” encompasses a wide variety of strategies and trading styles, underlying investment holdings and regional foci. It is this very variation from fund to fund which makes aggregating performance across all funds irrelevant for many investors (Fig. 18); by looking at strategic specifi c benchmarks to compare performance investors may be able to better gauge how each element of their hedge fund portfolio is performing.
The S&P 500 is the most favoured non-hedge fund specifi c benchmark among investors (Fig. 17). However, nearly a quarter of all investors felt that public market indices such as the S&P 500 are not relevant to hedge fund performance (Fig. 18). Certainly, when you compare the performance characteristics of the S&P 500 to hedge funds (Fig. 11 and Fig. 12) as well as from the return
characteristics sought by institutional investors (Fig. 4), then it is clear that hedge funds’ risk/return profi le and volatility are superior to these equity indices, even if the actual returns have not been over the past few years.
Alongside the diversity of the industry making it less relevant to benchmark across all strategies and the S&P 500 being no longer relevant to benchmark hedge funds to, investors also felt that some benchmarks might be unreliable or overestimate industry performance (Fig. 18). The investors suggested that these benchmarks can be improved by creating more specifi c benchmarks.
63%
19%14% 11% 11% 11%
4%0%
10%
20%
30%
40%
50%
60%
70%
Exte
rna
l Be
nc
hm
ark
-H
ed
ge
Fu
nd
Sp
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ific
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nc
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Fig. 17: Benchmarks Used by Institutional Investors to Assess Hedge Fund Performance
Source: Preqin Investor Survey, April 2014Benchmark
Pro
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Investors are largely satisfi ed with the level of performance of their hedge fund portfolios, both in absolute terms and on a risk-adjusted basis (Fig. 9). However, with over 10,000 hedge funds to choose from, how do investors monitor the funds in their portfolio against the wider performance of the industry?
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Fig. 18: Institutional Investor Concerns with Existing Benchmarks
Source: Preqin Investor Survey, April 2014
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Fig. 16: Methods Institutional Investors Utilize to Benchmark Hedge Fund Performance
Source: Preqin Investor Survey, April 2014Benchmarking Method
Pro
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In Brief Investors commonly use strategy-specific
benchmarks to compare their portfolio to the wider industry.
Equity indices do not reflect the diversity of the hedge fund industry or its risk/return characteristics.
Therefore equity indices such as the S&P 500 are becoming less relevant for benchmarking hedge fund performance.
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What’s Next for InstitutionalHedge Fund Portfolios?
Fig. 19 shows investors plans for their portfolios in the next 12 months, three years and fi ve years in regards to the amount they invest in hedge funds. As would be expected, in the short term investors in general are more likely to have fi xed plans for their portfolio, with the largest proportion, almost two-thirds, unlikely to change their exposure to hedge funds. However, 19% of respondents have plans to increase their target allocations, and just 4% plan to decrease the amount invested in hedge funds, which means that 2014 is likely to be another year when there are good levels of net infl ows from institutional investors. When looking at the number of funds they plan to invest in (Fig. 20), the picture looks positive for hedge fund managers currently seeking new investment; 45% of investors are either considering increasing the number of funds in their portfolio or have defi nite plans to do so, compared to 9% looking to reduce their number of relationships.
In the longer time frames, investors are less likely to have fi xed their plans, but the patterns look similar to the 12-month time frame. In fact, when discarding the investors which are unsure what they intend to do, the picture looks even more promising, with larger proportions of the remaining investors seeking to increase their exposure in the next three years and the next fi ve years.
As a result, the outlook for the industry looks promising; it is clear that in both the short, medium and long term investors will be putting more of their money to work in hedge funds and, at the same time, will be giving this to a larger number of managers. Of course, hedge funds will need to continue to provide the returns that investors seek – both on an absolute and risk-adjusted basis
– in order to maintain the institutional enthusiasm for the asset class. As we see the industry become more institutionalized, with investors taking a deeper look at performance, it is likely that we will see this continued shift away from comparing hedge fund performance to equity indices such as the S&P 500. As investors begin to view hedge fund performance more in relation to specialized hedge fund indices which better refl ect what investors need from the asset class, we may see more investors begin to invest in the asset class for the fi rst time as the true value of investing in hedge funds is revealed.
19%
24%
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46%
46%
4%
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0% 20% 40% 60% 80% 100%
12 Months
3 Years
5 Years
Will Increase theAmount TheyInvest in HedgeFunds
Will Not Changethe Amount TheyInvest in HedgeFunds
Will Decrease theAmount TheyInvest in HedgeFunds
Unsure at This Time
Fig. 19: Institutional Investors’ Plans to Change the Amount They Invest in Hedge Funds over the Coming 12-Month, 3-Year and 5-Year Periods
Source: Preqin Investor Survey, April 2014Proportion of Respondents
Over the past decade we have seen more and more institutional investors add to their hedge fund portfolios in order to add a source of low-volatility, risk-adjusted and non-correlated returns. Investors have been largely satisfi ed with the asset class’s ability to match these objectives and with the performance of the industry in general. In fact we are currently in a period when investor satisfaction with performance is at an all-time high. So, with the industry largely meeting the needs of investors, how will they change their hedge fund portfolios moving forwards?
17%
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0% 20% 40% 60% 80% 100%
12 Months
3 Years
5 Years
Definite Plans toIncrease Number ofFunds
ConsideringIncreasing Numberof Funds
ConsideringDecreasing Numberof Funds
Definite Plans toDecrease Number ofFunds
Unsure - ConsideringExposure in General
No Plans at this Time
Fig. 20: Institutional Investors Plans to Change the Number of Hedge Funds Invested in over the Coming 12-Month, 3-Year and 5-Year Periods
Source: Preqin Investor Survey, April 2014Proportion of Respondents
In Summary Thousands of institutional investors allocate
capital to hedge funds.
The amount of money they invest has increased over recent years and is likely to increase significantly in the years to come.
Investors use hedge funds to add a source of uncorrelated, risk-adjusted returns to their portfolio, NOT for double-digit returns.
Equity indices, such as the S&P 500, are increasingly seen as an irrelevant method of benchmarking hedge fund performance.
Hedge funds have largely lived up to investors’ expectations on an absolute and risk-adjusted basis over the short, medium and longer term.
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With global coverage and detailed information on all aspects of the hedge fund asset class, Preqin’s industry-leading Hedge Fund Online services keep you up to date on all the latest developments across the hedge fund universe.
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June 2014
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