European hedge funds win transatlantic battle
US hedge funds outperform in most strategies, except fixed income, where
a European manager might come top of the list.
In the sideways markets over the past decade, allocators were far better off in US managers, except for one strategy – fixed-income arbitrage, where the superior mathematical skills of quant-focused Europeans excelled.
Investors say the strong mathematical discipline underpinning European finance means continental managers in maths-based strategies outperform their US rivals, and that this discipline also preserves capital better in falling markets.
Cyril Julliard, co-founder of French-based investor ERAAM, says: “Europe has probably the best managers in the world when it comes to fixed-income arbitrage.
“The strength of mathematics in the French education system means many managers are good in analysing and trading derivatives markets, which plays well in fixed income.”
Fixed-income arbitrage managers seek to profit from punting on movements in the relative prices of related fixed-income instruments.
In 2008, when hedge funds lost 19% overall, fixed-income arbitrageurs did not do much better, posting an 18% loss. However, European fixed-income arbitrage strategies actually rose by 11%, says Ben Funk (pictured), head of research at investor Liongate Capital Management.
“In drawdown periods such as 2008, European managers did a better job – a fair bit of which was due to fixed-income arbitrage,” he says.
“Over the past five years, US managers have been stronger than European managers in all strategies but fixed-income arbitrage.
“In continental Europe, there is a hard quant background, which would give managers deep skills in maths. This lends itself to fixed-income strategies, which are more quant-based.”
Julliard says European managers, in general, concentrate more on generating returns independent of market direction (or alpha), whereas US managers are better to have for riding the market direction (or beta).
He says: “When there is positive beta, the US hedge funds do much better than in Europe, and it is the opposite in bear markets. In 2009, when we had the big rally in markets, the US hedge funds were returning 10% to 15%, whereas Europeans were making maybe 5% to 7%.”
Julliard says European managers are generally more risk averse than their American peers – a trait perhaps fuelled by US investors expecting high returns of up to 30%, or even 40%, per annum.
But in the ‘lost decade’ for equities to 2010, US managers almost quadrupled their investor’s money (up 273%, according to Eurekahedge), while Europeans ‘only’ tripled it (200%).
Funk says: “A lot of US managers tend to be more trading-orientated in their approach, whereas European managers may be more fundamental. The trading orientation has allowed a better compounding of returns over time, although not in the shorter term in every market.”
The top 20% of US managers were also better over five years (up 33% average annualised) than the best Europeans (up 20%), Funk notes.
Over the past five years, the average US manager returned about 7% per annum, whereas the average European made about 3.5%.
The long-term performance from each side of the Atlantic stands hedge funds in good stead generally when compared to global shares (MSCI World Index), which fell 20%.
Americans’ superior returns must, however, be weighed up against other, non-investment considerations.
Julliard says investing in European hedge funds, as ERAAM does exclusively, benefits from tighter regulation here, which also gives rise to healthy transparency.
He adds: “Also, the liquidity of European hedge funds is better, on average, than in the US because the investor base is much more demanding.
“In Europe, about 30% of hedge funds offer monthly liquidity, with 50% offering quarterly liquidity, whereas in the US about 30% will offer quarterly and 50% annual redemptions.”
Funk notes managers might, in part, be formed or at least influenced by the history of their markets, or the fate of geography.
“Because of Europe’s international position ‘between’ emerging markets and the US in terms of the time zone, you find a lot of good discretionary macro managers, too.”