October 19, 2017

What’s the Outlook for Hedge Funds in the Year 2013?

The waters look murky for hedge funds in 2013, especially SAC. Pictured is SAC manager Steve Cohen's reported $8 million artwork, a shark in a tank of formaldehyde.

The market’s direction is anyone’s guess. Hedge fund managers are supposed to add alpha, or value. Their goal is to make better picks than the general market (or their respective index), minimize risk, and thus provide a higher risk-to-reward profile for investors. In 2012, hedge funds that reported their performances returned less to investors than the broader S&P 500 market. So the question now is, “What’s the outlook for hedge funds in the Year 2013?” Beverly Goodman at Barron’s sizes up the industry’s current trends and what it may mean for the coming year.

2012 was a pretty uninspiring year for the hedge-fund industry. Plagued by unfavorable comparisons with lower-cost and better-performing mutual funds, the industry ended the year with a scandal, when the best-performing hedge fund, Steve Cohen’s SAC Capital Advisors, became embroiled in a scandal. Industry observers are cautiously optimistic that 2013 will shape up to be a better year.

That said, it doesn’t look good for SAC. An intense, six-year, multiagency investigation appeared to culminate in November with insider-trading allegations against one of SAC’s portfolio managers, but then it rapidly expanded to include Cohen himself. Just 40% of the $14 billion fund’s assets are from outside investors. Citigroup’s (ticker: C) private bank filed to withdraw $187 million late last week, though Reuters reported that Blackstone Group (BX), with a $550 million stake one of SAC’s biggest investors, appears to be content to leave it in Cohen’s hands.

One trend that nearly everyone has noticed and expects to continue is the increase in institutional money going directly into hedge funds. Last year, investors pulled $28 billion out of funds of funds, but $27 billion went directly into hedge funds.

Institutional investors are making up the bulk of the new money. Exact figures are hard to come by, but most estimates put institutional money at 60% of hedge-fund assets today; just five years ago, prefinancial crisis, 60% of the industry’s assets were from high-net-worth investors. That’s a significant shift in the $2.3 trillion industry, notes Ken Heinz, president of research firm HFR.

That cost-consciousness on the part of institutions is driving fees down as well—for investors big enough to demand it. “Any midsize to larger investor writing a $15 to $20 million check is going to expect some sort of fee concession,” says Noel Kimmel, head of Cantor Fitzgerald’s prime brokerage.

Equity hedge funds will likely continue to struggle this year. “They got a bad rap for lagging performance in 2012,” says Peter Laurelli, vice president of research for eVestment. “But there were a lot of negative things lurking, but the equity markets never really manifested that negativity. In environments like that, hedge funds are going to be consistently defensive.” Perhaps that’s why the average long/short fund returned just 8.8% in 2012, while the S&P 500 returned 16%.

It seems hedge funds surprisingly underperformed in 2012, especially stock funds. Investors need to keep in mind a bias in hedge fund index measurements – namely, that the funds choose whether to report their performance or not. Also funds that close down are then discontinued from inclusion in the index. On the other hand, one should probably take 2012 into account as part of a larger investment horizon. Even though public companies and hedge funds are measured quarterly by investors, Warren Buffett would tell you to look way beyond one year’s performance. So what’s the outlook for hedge funds in the Year 2013? “Cautiously optimistic,” but due diligence is always a good investment.

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