Agecroft Partners is a hedge fund consulting and marketing firm, and as such has to keep its eye on the crystal ball.
With that in mind, Donald Steinbrugge, the firm’s founder and managing partner, has looked at how the industry would fare in the event of a market decline like that of 2008 sell-off.
He notes in a written statement that mainstream media were full of negative commentary about hedge funds when asset prices declined and volatility spiked from mid-September to mid-October.
Steinbrugge doesn’t expect a 2008-type sell-off in the near future. But what if?
The outcome for the hedge fund industry would be very different, he writes.
The makeup of the hedge fund investor base changed dramatically since 2008 as pension funds — stable and long-term investors — have been significant allocators to the sector. According to Steinbrugge, “this trend could actually be enhanced by a market decline as pension funds strive to reduce their unfunded liability by enhancing returns and reducing downside volatility.”
In addition, endowments and foundations, major redeemers after the 2008 market correction, have repositioned their portfolios to better withstand liquidity events.
Steinbrugge explains that it was common practice for these investors to overallocate to private equity in order to maintain a targeted allocation. This became a big problem in 2008, when capital calls increased while return of capital stopped.
Now, he writes, most liquidity issues have been resolved, and endowments and foundations will be much more active allocators to hedge funds in the event of a similar selloff.
Finally, the fund-of-funds segment has become more stable. They are using less leverage, and their investors are better informed about the products they are buying.
Another big difference today is that hedge fund investors and managers are using significantly less leverage than in 2008 when highly leveraged funds of funds closed, suffered huge withdrawals or saw lenders reduce their leverage. This in turn led to significant redemptions from the underlying hedge funds.
Today, individual hedge funds use less leverage, which should help their performance in a down market and reduce the amount of withdrawals, Steinbrugge writes.
Further, hedge funds’ liquidity terms and underlying investments have become better aligned. In 2008, a mismatch in a fund’s liquidity terms — often monthly or quarterly — and its underlying investments worked well as long as the fund experienced positive flows.