Only four FOHFs made money in 2011, S&P Capital IQ says

Hardly any fund of hedge funds (FOHFs) made money in 2011, and only four S&P Capital IQ graded FOHFs delivered positive returns during the year, according to research by S&P Capital IQ.

During last year, FOHFs experienced a slightly bigger loss than equities with -5.7% on average versus the S&P Global 1200 return of -5.1%.

Positive returns were delivered by Aberdeen Orbita Capital Return (+3.0%), The Absolute Fund (+0.2%), HDF Multi Reactive (+0.9%) and SEB True Market Neutral Portfolio (+4.2%), all funds managed fairly conservatively.

“Market conditions were tough for hedge funds. In theory, they are supposed to make money in all market conditions. But that has proved to be hype. In reality, their performance tends to suffer when equity markets are falling, albeit to a lesser degree. They are generally low, but positive beta. They also struggle during periods of liquidity withdrawal,” said Randal Goldsmith, fund analyst and sector head at S&P.

He added low dispersion within security markets by historical standards was a difficult background for strategies such as long/short equity hedge and erratic, politically driven movements in markets made life difficult for systematic traders and quant hedge fund strategies.

Meanwhile, FOHFs’ share of hedge funds under management continued to decline during the past 12 months.

“Based on our observations on the assets of S&P Capital IQ graded FOHF groups, we estimate that aggregate assets under management of FOHFs have fallen to around $900bn after an average return of -3% over the 12 months to 1 March 2012 and modest outflows,” Goldsmith said.

FOHFs’ performance has been very disappointing since 2007, with annualised returns of around 1% over the past five years, marginally ahead of global equities but behind fixed income.

S&P says it does not make sense for an investor to be fully invested in them through thick and thin, given that FOHFs can make unexpectedly large losses and that they can become illiquid when market conditions deteriorate.

“However, we still think that the FOHF model has a role to play. The returns of hedge funds are far from perfectly correlated with traditional asset categories, and a FOHF offers both strategy and manager diversification. An allocation to FOHFs can therefore improve the overall efficiency giving a better risk and return trade-off of an investor’s portfolio,” Goldsmith said.

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