Cautious optimism for 2011 as tough 2010 ends on strong note

Wed Jan 26, 2011

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Nobody would claim that 2010 was a great year for hedge funds

By Nick Evans

Nobody would claim that 2010 was a great year for hedge funds. For most managers it was a long, hard slog. Performance was OK – exceptional in a few cases, mediocre in many and fairly unexciting for the most part.

Asset-raising was still a struggle for all but a few – with the concentration of assets by risk-averse investors into the brand-name managers creating an increasingly bifurcated situation whereby a handful of top funds were able to close again while the vast majority of smaller operations found capital inflows very hard to come by, almost irrespective of performance.

And there were plenty of reasons for investors to be wary – with the high level of correlation with volatile equity markets being a persistent concern, especially in months like May and November, and with regulatory uncertainty in Europe and around the globe further muddying the waters in the financial world.

The macro outlook offered no shortage of causes for concern, with the Eurozone sovereign debt crisis, overheating in emerging markets and global inflationary pressures heading a long list of macro-economic worries.

The result was a very febrile environment in all major asset classes, marked by a constantly changing ‘risk on, risk off’ sentiment leading to market reversals that were rapid, regular and frequently extreme.

Coming after the debacle of 2008 and the recovery of 2009, it was another tough and unpredictable year – and there were plenty of headwinds to fight against throughout the year.

But it ended on a high note – with good performance across the board in December, with inflows from investors starting to gather momentum fast in the final months of the year and with the flow of new funds and firms also returning to more respectable levels, although still a long way from the pre-crisis peak.

And there are grounds for optimism heading into 2011, with a strong underlying tone to markets helping to underpin the growing sense of confidence among managers, investors and service providers alike.

So what are likely to be the defining features of the year ahead? Firstly, the impact of the prop trading exit from banks – which could create a whole new generation of hedge funds.

Not all of the prop teams will end up as new standalone hedge funds overnight, to be sure. Some will team up with other hedge funds, private equity firms or other financial groups. Some will move into banks’ asset management units. And some will simply dissolve.

But the trend is sure to provide a welcome injection of new blood into the hedge fund industry – and for that alone, if for very little else, the regulators in the US and the rest of the world are to be thanked.

On the flip side, the wretched AIFMD will keep rumbling on in Europe, with the detailed Level 2 stage of the implementation process still requiring a considerable amount of work, focus and close monitoring to ensure that the devil is not let loose again in the detail.

The industry will continue its reshaping – with consolidation accelerating through mergers and acquisitions, lift-outs of teams, strategic partnerships and the like – and with a number of potentially powerful new ‘absolute return’ investment firms looking to exploit the evolving convergence between traditional and alternative, offshore and onshore products.

And life will continue to be tough for smaller firms and boutiques – although there are already welcome signs that some of the savvier investors are turning their attention away from the safety-first big battalions back to the smaller funds that form the backbone of the industry and where many of the best investing opportunities are often to be found.

In terms of specific strategies, it is anyone’s guess as to which are likely to perform best or worst in the year ahead. But it is clear that investors are looking as much to the micro as the macro now, with an increasingly heavy focus on event-driven and special situations-type strategies in what is likely to be an active marketplace for M&A and corporate events.

It would be an overstatement to say that hedge funds have generally had their reputation enhanced by the crisis – although it is certainly true in a number of individual cases. But they have come through it much better than might have been feared – and the industry enters what is likely to be another eventful and unpredictable year in increasingly robust shape.

We wish all our friends across the industry the very best for a prosperous and happy 2011 and look forward to seeing how events unfold.

ISSN: 2151-1845 / CDC10004H

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