Hedge fund assets will reach an all-time high in 2015, use of social media by industry participants will accelerate and the pace of fund closures will pick up, according to Donald Steinbrugge, the founder and managing partner of Agecroft Partners.
At the beginning of each year, Agecroft Partners, a hedge fund consulting and marketing firm, taps into its contacts with some 2,000 institutional investors and sundry hedge fund organizations to predict what the year ahead holds.
Following are Agecroft’s predictions of top industry trends in 2015:
1. Higher volatility leads to greater Alpha
Over the past five years, hedge fund returns have been driven mainly by market beta because of rising equity and fixed income valuations, enhanced by high correlations and lower volatility within the capital markets, according to Agecroft. Since September, however, capital market volatility has increased, and Agecroft expects this to continue as volatility levels approach historical averages. With large price movements, skilled managers find it easier to add value through security selection when security prices reach price targets more quickly, thus enabling them to reinvest capital in other opportunities.
2. Strategies that benefit from increased volatility
Market neutral equity, arbitrage strategies, global macro, CTAs, long/short equity and fixed income trading strategies are benefiting from increased volatility. According to Agecroft, these strategies will be in demand both because of their increasing ability to generate alpha, and as a hedge to all-time-high equity and fixed income prices.
3. Advantage to smaller managers
Smaller managers will continue to outperform their much larger and better-known peers, Agecroft predicts. This is because many brand-name managers’ assets have swollen well past their optimal asset level to maximize returns for their investors. As inflows increase, they find it harder to add value through security selection. The big managers also have an incentive to reduce portfolio risk in order to maintain assets, as this increases the probability of continuing to collect large management fees. As well, some of the largest managers have difficulty staying motivated once they’ve become ultra wealthy.
4. Shutting down
Agecroft expects the pace of hedge funds closures to quicken this year owing to four factors:
- With the current number of hedge funds near an all-time high of 15,000, and given a consistent rate for hedge funds ceasing operations, fund closures should also be at an all-time high
- The increase in hedge fund managers has reduced the average quality of funds in the industry, and many lower quality managers will close down
- Increased capital market volatility increases the divergence in overall return between good and bad managers, resulting in turnover as bad managers get fired and money is reallocated to those who outperform
- The competitive landscape for small and midsize managers is becoming increasingly difficult, as asset flows are being driven increasingly by brand and distribution, which they lack, and their superior quality alone can’t generate capital inflows.
5. Assets soar
Agecroft expects total hedge fund industry assets to reach a new all-time high in 2015. Two factors are at work here: investors moving assets out of long-only fixed income to enhance forward-looking return assumptions, and other investors shifting some assets out of the equities to hedge against a potential market sell-off. Agecroft foresees industry assets rising by $210 billion, or 7 percent, based on its forecast of a 2 percent increase owing to net flows and 5 percent from performance.
6. Founder’s share trend
Over the past couple years, use of a Founder’s share class — a 25 percent to 50 percent discount on standard hedge fund fees intended to incentivize investors to invest on day one in a new fund — has expanded to include a significant percentage of hedge funds with less than $100 million in assets. Now, according to Agecroft, this ceiling is increasingly being raised to $200 million and beyond for investors willing to either allocate a large dollar amount or accept a longer lockup. This trend, it says, adds downward pressure on industry fees that are also being squeezed by large institutional investors.
7. Competitive 40 act hedge fund marketplace
Hedge fund 40 Act funds have proliferated over the past couple years, according to Agecroft. This has made it harder for new entrants or smaller managers to raise assets unless they are aligned with a strong distribution partner.
8. AIFMD-reduced marketing in Europe
U.S. marketing activity in the Eurozone has plummeted because of the Directive for Alternative Investment Fund Managers (AIFMD), and Agecroft doesn’t expect it to pick up until hedge funds can register across the region with a single registration. The European Securities and Markets Authority is expected to render an opinion on this matter for non-EU funds and managers in July.
Agecroft said Europe has historically accounted for about a quarter of hedge fund asset flows to U.S.-based managers. The AIFMD is taking an especially big toll on smaller managers that lack the resources to register in individual EU countries. European investors tend to invest in smaller managers because of their higher return potential, and in turn are being hurt because they aren’t seeing many of the top emerging managers.
9. Growth in outsourced investment management
The rising cost of staffing an investment office and poor portfolio returns are promptingmore and more endowments and foundations to outsource the investment management of their funds to an outsourced chief investment officer. Although a boon for the OCIO industry, this trend will lead to significant fee pressure due to the increased competition, according to Agecroft. This is quite a change from a few years ago when little fee pressure existed and investors often felt lucky to be accepted as clients.
10. Social media
Hedge fund managers, investors and service providers are increasingly using social media for research, to build stronger relationships and to promote a firm’s brands in the marketplace. Some managers are also using it to promote their investment ideas in order to create a catalyst for the security. New firms are coming into existence to address the demand for hedge fund social media.
LinkedIn is broadly used across the industry, but last year many participants used Twitter for the first time. Agecroft expects use of Twitter to increase in 2015. In addition, some organizations are beginning to use YouTube to create videos they can post on websites, distribute through social media or email to a distributions group.