Funds of hedge funds outperform hedge funds over 12 months
But typical FoHFs ‘more exposed to market risks now than in recent memory'
Funds of hedge funds (FoHFs) outperformed hedge funds on an equal-weighted absolute basis over the last 12 months ending May 2015, returning 6.65% versus 5.84%. Measured over the last five years, hedge funds have outperformed FoHFs by approximately 2% per annum.
FoHFs saw net investor allocations during the first half of 2014, but outflows in the second half forced financial year 2014 flows to be approximately flat. Net redemptions continued into Q1 2015, with investors pulling approximately $16.74 billion from FoHFs during the period. This marks a break from the similar trend between quarterly hedge fund flows and FoHF flows during 2014; hedge funds enjoyed net allocations in Q1 2015 of $26.48 billion. Commingled FoHF assets now account for 30.41% of commingled hedge fund assets under management (AUM), down from 31.87% the year before and 40.38% five years prior.
Equity long/short strategies are by far the largest strategy holdings within FoHF portfolios followed by event-driven funds. Event-driven strategies overtook macro as the second-largest strategy concentration in Q1 2013.
eVestment's recent report on the FoHF industry uses 2,521 unique FoHFs and 7,519 hedge funds in the eVestment research database for its analysis, looking at performance and asset flow trends, and portfolio characteristics.
The reduction in concentration of macro strategies within FoHF portfolios coincides with macro hedge fund redemptions, particularly from Q4 2013 to Q3 2014. During that span, eVestment estimates that macro hedge funds lost an estimated $18.2 billion due to investor redemptions.
It is also of interest to note the decline of the concentration of managed futures strategies within FoHF portfolios for a few reasons. First, similar to the influence of the decline of macro strategies, managed futures have lost a significant amount of AUM over the last several years, beginning in Q2 2012. Second, a more positive point is that managed futures hedge fund flows turned up in Q1 2015, but there was still a reduction in their concentration within FoHF portfolios. Performance was likely a relatively muted factor in this time frame. If FoHFs were not primarily responsible for the group's first quarterly inflows in nearly three years, then institutional investors likely played a role in the roughly $8.5 billion of Q1 2015 net inflow. This is meaningful because it is the first good evidence institutional investors are warming to the idea of this true alternative strategy type in their portfolios.
While the focus on equity long/short strategies has likely played a large role in the last 12-month performance turning in favour of FoHFs, another factor may be the ongoing trend of increased concentration of underlying funds within portfolios, which has continued consistently since Q4 2013.
In an effort to produce marketable performance, and to satisfy institutional demands in the marketplace, FoHFs may have put their portfolios in a more vulnerable position. Higher concentrations of holdings – albeit in larger funds – increased equity exposures and a reduction in less correlated strategies, imply the typical FoHF portfolio is more exposed to market risks now than in recent memory at a time when geopolitical factors are high.
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