By Nick Evans
Lansdowne founder Sir Paul Ruddock put it best of all. Speaking at the annual EuroHedge Summit in Paris in late April, he cut to the quick on the issue that dominated most of the discussions and debates over the two days: performance.
“The hedge fund industry is like a luxury brand,” he said. “We charge a premium price and that means that you have to deliver a premium product. We need to deliver.”
Ruddock’s comment encapsulates the growing sense of unease among managers as well as investors that hedge funds are not doing what they are supposed to do – or, more to the point, are not doing what their investors want (or expect) them to be doing.
The further away it gets, the worse 2011 seems for the industry as a whole – worse, in many ways, than 2008. Yes, markets were difficult. But they were not impossible. And these kinds of skittish and politics-driven market conditions could well be the norm for a while, with the events of the last few weeks giving every sign that 2012 could be a repeat of 2011.
What is dismaying investors (and many managers too) about recent performance – in a period when very many funds have been underperforming the markets, and at a time when they should quite reasonably have been expected to outperform – is that hedge funds do not appear to be providing any of the benefits that they are commonly assumed to offer.
Correlations have been at an all-time high – at a time when investors really need them to be as low as possible. Worse, many funds have appeared to be correlated mainly on the downside – exposing investors to the risk-off moments of downward market direction without being able to deliver the upside in the corresponding risk-on periods.
The overall volatility of returns may be lower than the underlying markets, which is some comfort and value to investors. But that is scant consolation for the fact that absolute returns have been minimal – or, in many cases, negative.
Nor does it compensate for the fact that hedge funds in general have seemed for some time now to be providing negligible diversification benefits when viewed in the context of investors’ overall portfolios and needs.
While it is perfectly sensible and right for AIMA and others to draw attention to the clear long-term outperformance of hedge funds over the past two decades, that is unlikely to make those investors who have only been allocating to hedge funds in the last few years feel any better about the fact that they have suffered losses in two of the last four years.
So far investors have broadly kept faith. Overall redemptions have been low and there is growing evidence that the more institutional nature of the investor base these days has indeed provided those managers that can attract institutional capital with a stickier, more patient and longer-term capital base.
But the fact that there has not been another sudden rush for the exits does not mean that investors are satisfied. Far from it. There is clear disappointment among all types of investors. And there is mounting concern that hedge funds are not going to help them in the ways they had hoped – whether in terms of reduced volatility, lack of correlation, portfolio diversification or protection against the tail risk events that are of such paramount concern to all investors at such a challenging and dangerous time.
Of course there are valid questions as to whether the huge changes in the nature of the hedge fund investor base over the past five years or so have fundamentally changed the industry in terms of the increasingly divergent interests of managers and investors.
Do investors know what they want from managers? Do managers know what investors want? What is fair to expect? What is it fair to charge? Is it becoming impossible for managers to run money simultaneously for different types of investors that want different things? Is the bifurcation of the industry that some people have long predicted between an institutional sector and a non-institutional sector starting to become inevitable?
But that is all a debate for another day. Right now, in an environment full of risk and fear (and opportunity), investors need hedge fund managers to prove to them that they were right to give them their money – and that both their investment and their trust are justified.