Largest hedge funds set for redemptions, warns Agecroft Partners

The world’s largest and best known hedge funds are likely to experience “heavy withdrawals” in coming months as investors see generally poor performance and “question whether these large managers have morphed into asset gatherers at the expense of performance,” according to Don Steinbrugge, founder of independent fund marketers Agecroft Partners.

Steinbrugge (pictured) said investors were likely to “continue shifting their assets to smaller, more nimble managers.

This will be a turnaround from the case immediately following the 2008 financial crisis, when “a vast majority of inflows went to hedge fund managers with assets greater than $5 billion – for a period of time after 2008 this was over 100% of net flows.”

If redemptions do eventuate, data from fund administrator GlobeOp Financial Services suggest much will be recycled rather than removed from the industry.

Some 2.71% of the assets GlobeOp administers were subject to redemption requests by mid-August – the lowest August figure since 2008, slightly up on 2.08% in July, but far below the 19.3% registered in November 2008.

Hans Hufschmid, GlobeOp’s chief executive, called August’s figure “encouragingly low given recent market volatility, and at this time, we see no sign of investors moving out of hedge funds.”

Agecroft predicted some net outflows would be unavoidable from the industry overall, given sharp falls, “but nowhere near the extent that was experienced in 2008”.

Steinbrugge predicts investors’ scenario analysis will guide them to recycle to managers offering “diversification benefits, downside protection or a focus on less efficient areas of the market”.

He highlighted global macro and computer-driven as two strategies likely to prove popular, and market-neutral, arbitrage and trading oriented-strategies. Within long/short equities, flexible mandates will find favour, while large-cap European and North American focus will be shunned in favour of emerging market programs.

Within fixed income, a greater focus will be on active traders or investors in less efficient pockets of fixed income markets, such as structured credit.

He noted at most 10% of hedge fund allocators have investment plans on ice, despite market volatility (Vix index) spiking twice above 40 this year. It has not neared 80, the level it briefly breached in 2008, when “the vast majority” of investors were postponing fresh allocations or redeeming.

Don Steinbrugge, founder, said a “dramatic increase in volatility” and the S&P 500 falling 10.5% this year, had made investors “nervous, but appetite to make new hedge fund allocations and to meet with managers has seen very little change”. Steinbrugge’s marketing firm meets about 1,000 investors a month.

He does not foresee the level of redemptions of 2008, at $155bn, though questioned how loyal investors would be if losses continue.

According to Hedge Fund Research’s narrow investable HFRX industry index, managers have lost 4% this month, and 6.1% this year.

Steinbrugge gave various reasons redemptions would not match the end of 2008, when funds fell 10% from September.

He said the industry’s investor base is very different now, dominated by institutional investors “much more long term-oriented and stable”. Indeed, he said current volatility could fuel more pension allocations, as yields of 3% on long-only fixed income holdings would not meet actuarial assumptions of returns, typically between 7.5% and 8%.

In addition, endowments and foundations criticized for redeeming in 2008 have repositioned portfolios to better withstand ‘liquidity’ events.

“There has been a much greater focus by investors on liquidity terms and their alignment with the underlying investments. Investors are much more willing to accept longer lock-up provision and redemption cycles for less liquid strategies, and are avoiding those funds with mismatches in liquidity terms.

“In addition, those managers who investors perceived self-servingly employed a gate provision at the end of 2008 have been banished from future consideration. We should see the reduced use of gates and suspension redemptions in the future.”

Funds of funds are now more stable, use less leverage and have better informed clients, he said. “Before 2008, many fund of funds were selling their funds as a T-bills plus 400bps product [and] many investors didn’t realize that they could experience material negative returns. When investor’s experience is dramatically different than their expectations, they are much more likely to redeem.”

A significantly reduction in leverage by hedge managers should “help performance in a down market and reduce the amount of withdrawals”, Steinbrugge said.

He added there was less likelihood of another fraud mirroring the $18bn crime of Bernard Madoff, uncovered in December 2008, as due diligence has become more exacting.

Finally, he said, there are few good alternatives to hedge funds to protect capital, in contrast to 2008.

“Today money market funds are yielding close to zero, and generating a negative real return; the 10-year US Treasury is yielding approximately 2% and could sustain a large market value decline if interest rates rise; gold has seen a significant rise in value and now is at an all-time peak; and investors obviously don’t want to increase their equity holdings if they expect a major decline there.”

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