By Nick Evans
The best that can be said for 2011 is that at least it was not as bad as 2008. And the best that can probably be hoped for 2012 at this early stage is that it is no worse than 2011.
Being a hedge fund manager at the moment is tough, to say the least. Politics and macro events are adding a whole extra layer of investment risk, making most fundamentally based strategies extremely hard to deploy in a constantly changing risk-on/risk-off environment.
But being an investor is arguably even tougher. Knowing where to allocate money and when; deciding which managers to select; understanding what managers are doing and why it either is or isnt working, when the managers themselves often cant figure that out; judging when to sit tight and when to bale out. These are hard choices to make at the best of times. At a time like this, they are fiendishly difficult.
The simple fact is that hedge funds did not generally perform as well as had been hoped or expected in 2011. Overall returns were disappointing. Many brand-name managers that should have done well in 2011 signally failed to do so. And success or failure for investors in strategies like long/short equity or macro was down more to individual manager exposure than to strategy allocation with huge dispersion between the good and bad performers.
So, just as individual stock-picking is said by many long/short managers in their own defence to be almost impossible in the current macro-dominated climate, it is not surprising that many investors are also questioning their ability to pick individual managers at the moment.
This may be one additional reason why so many investors, particularly in the institutional space, are favouring systematic and quant-based investment processes over discretionary strategies that rely so heavily on the ability of key individuals to read things right in such a challenging and unpredictable market.
Aside from fixed income and emerging-market debt, quant-based equity, market-neutral and stat arb was one of the few areas that performed well in 2011 with most quant equity strategies outperforming their peers in the fundamental/discretionary space by a margin.
CTAs and systematic managed futures funds did not do so well in 2011. But the case for investing in CTAs has already been made by what they achieved in 2008. After years of scepticism about black boxes and lack of transparency, investors now buy the idea of negative correlation in times of extreme equity market stress and money is pouring into CTAs.
Not all discretionary strategies did badly in 2011, to be sure. There were many notable performers in equity, in macro, in credit and in other areas. But most did not perform well and, for many investors, the odds on being with the right ones at the right time seem to have become increasingly unfavourable.
Unlike with discretionary funds, which tend to rely on an individual or a few key individuals, systematic and quantitative processes are exactly that a process, usually computerised and part of an institutionalised DNA, and one that pretty much eradicates key-man risk.
Furthermore, they appear to generate returns that add genuine diversification and lack of correlation to investors portfolios at a time when investors really need both of those things and the same cannot be said by many discretionary managers, whose correlations with markets have been rising to uncomfortably high levels.
Besides the growing shift into systematic strategies, the same drivers may also lead to increased take-up in hedge fund replicators and other quant-based ways of gaining broad hedge fund exposure without having to select individual managers in individual strategies.
And secondary market activity may also rise rise, as investors take the view that hedge funds are now more of a market than a club these and that access to managers should be freely tradable rather than seen as some kind of privilege.
All of this could, of course, change quickly if the market and macro environment were to change and the potential for upside shocks is probably as great as for further downside risk.
But, at a time when there are many high-quality launches around from managers with proven pedigree and when there are different ways for investors to gain hedge fund exposure other than backing individual managers, the pressure on many funds even those who have performed excellently over the years to raise their game in 2012 will be intense.