Hedge Fund Performance; A year in review – 2016
By Colin Lloyd
As we end 2016 I want to take the opportunity to look back over the past 12 months, but first I quick up-date on December’s performance:-
|December||No. of Funds||YTD|
|Barclay Hedge Fund Index||1.22%||2104||6.20%|
|Global Macro Index||1.99%||128||1.80%|
|European Equities Index||1.90%||82||-4.29%|
|Distressed Securities Index||1.76%||36||14.28%|
|Event Driven Index||1.67%||84||11.28%|
|Equity Long Bias Index||1.54%||276||5.26%|
|Fixed Income Arbitrage Index||1.40%||32||5.50%|
|Multi Strategy Index||1.00%||78||4.72%|
|Convertible Arbitrage Index||0.98%||12||5.32%|
|Equity Long/Short Index||0.94%||324||1.91%|
|Fund of Funds Index||0.93%||387||-0.44%|
|Merger Arbitrage Index||0.83%||37||6.08%|
|Emerging Markets Index||0.77%||249||10.27%|
|Equity Market Neutral Index||0.49%||81||0.82%|
|Pacific Rim Equities Index||0.32%||26||0.18%|
|Healthcare & Biotechnology Index||0.31%||33||-2.75%|
There were positive returns across the board. Global Macro, which has had a challenging year, came out at the top +1.99%, helped by a stronger US$, lower T-Bonds and higher oil prices. European Equities finished the month +1.9% but remain the poorest performer YTD -4.29%. This year’s best performer, Distressed Securities, moved higher again last month +1.76% to finish 2016 +14.28%. Event Driven was close behind +1.67% for the month +11.28% YTD.
The Year in Review
The Barclayhedge Hedge Fund Index finished 2016 +6.2% which is the strongest performance since 2013. The chart below shows the performance of the index since 1997:-
The combination of lower interest rates and the positive correlation between the Hedge Fund Index and long only stock indices, goes a long way to explaining the downward slope of this chart.
There are a couple of issues that I want to address, firstly, the small number of reporting funds at the beginning of the data set; this effect is likely to reduce the average return over time: and, secondly, “survivorship bias” which inflates the return of the index, since the reporting funds change over time, new entrants replacing those which fall by the wayside. These effects are to some degree off-setting.
2016 was, nonetheless, pleasing, this was the year in which many of the world’s bond markets followed the lead of Switzerland and plumbed the depth of negative yields. If low interest rates make it challenging for hedge funds to deliver returns then rising interest rates create an even more difficult environment. Since July government bond yields have been rising.
For a more granular analysis of hedge fund sub-sectors, Hedge Fund Research produce a wide range of indices, I have listed the top performing sub-sectors:-
|Emerging Markets – Latin America||26.86%|
|Emerging Markets – Russia/Eastern Europe||25.86%|
|Relative Value – Yield Alternatives||18.17%|
|Equity Hedge – Energy/Basic Materials||17.90%|
|Event Driven – Distressed/Restructuring||14.34%|
|Event Driven – Special Situations||12.15%|
Within Emerging Markets, Latin America (+26.86%) and Russia/Eastern Europe (+25.86%) provided the most spectacular returns but given that the Brazilian, Bovespa Stock Index closed the year up 39% and the Russia, RTS Index was 56% higher by the year end, these returns are not entirely a surprise. Yield Alternatives, however, returned +18.17% which, given that it is a Relative Value strategy, is noteworthy.
Much of the commentary about hedge funds during 2016 concerned the poor returns offered by the sector over the last few years. A number of US Pension Funds have maintained annual return targets of 7.5/8% in order to meet their liabilities. Many are struggling with rising shortfalls, often due to an obsession with low volatility.
The CBOE Eurekahedge Long Volatility Hedge Fund Index finished 2016 with a volatility of 6.39% – slightly higher than the long run average. By comparison the CBOE Volatility Index, which measures the volatility of the S&P500, ended at 12.28%, which is below its long run average. The S&P500 Stock Index ended the year up 9.86% which, when adjusted to the same basis as the Long Volatility Hedge Fund Index, delivers a return of 5.13%. This is lower than the 6.2% return of the Barclayhedge Hedge Fund Index. Sadly this is unlikely to stop the constant call for lower fees from institutional investors.
The effect of the fall in interest rates on declining annual performance shows even more clearly in the Barclayhedge CTA Index than in the Hedge Fund Index. The chart below goes back to the peak of interest rates in the early 1980s:-
2016 has been a difficult year for CTAs as the table below shows:-
|December||% of Funds||YTD|
|Barclay CTA Index||0.33%||85.84%||-1.05%|
|Fin./Met. Traders Index||0.99%||85.71%||1.65%|
|Systematic Traders Index||0.44%||86.97%||-1.48%|
|Diversified Traders Index||0.36%||87.79%||-2.39%|
|Currency Traders Index||0.32%||81.25%||1.60%|
|Discretionary Traders Index||0.27%||80.85%||-0.86%|
|Agricultural Traders Index||-0.08%||73.08%||-2.44%|
During January and February the sector performed strongly with returns derived from shorts in JPY and longs in JGBs and European bond markets. By May many of these trends had reversed with A rising JPY and falling precious metals taking many managers into negative territory. June and July saw further positive performance with a rebound in precious metals and a general rise in major bond markets. From August onwards many of these trends reversed. By the eve of the US election in November exposures were reduced and performance was generally negative. Long US$ and Stock Index positions, together with long exposures in Copper helped the sector to claw back some of its losses by year end.
Currency Traders were the only sub-Sector to finish the year in positive territory, helped by the steady rise of the US$ throughout 2016. The Systematic and Diversified sectors, which attract the majority of assets, both suffered a second year of negative returns. In fact the Systematic Index has only delivered three years of positive returns in the last nine.
Assets Under Management and Fees
As with hedge fund performance, different data providers publish differing estimates on the size of the industry. The table below is from Barclayhedge:-
|Fund of Funds||400||383|
This indicates moderate growth, except in the Fund of Fund sector. HFR also indicate a rise, estimating total Hedge Fund AUM at a slightly more modest $2.97trln. EurekaHedge, by contrast calculate that total Hedge Fund AUM declined by $12.2bln – net redemptions totalled $42.5bln during 2016. Meanwhile eVestment calculate that total AUM increased by $13bln, but go on to state that total net redemptions amounted to $106bln.
The data providers may differ but overall this points to consolidation rather than collapse in the industry. Eurekahedge reveals that a net 44 hedge funds closed in 2016 – the first fall since 2000.
Preqin, another hedge fund data provider, estimate that in 2000, 52% of funds charged less than 2%, whilst in 2016 that figure has risen to 67%. Albourne Partners, which advises institutional investors with more than $400bln invested in hedge funds, reports that at least two dozen institutional style managers have adopted a “1-or-30” fee model since Q4. According to Alboune’s Jonathan Koerner, “The objective of 1-or-30 is to more consistently ensure that the investor retains 70 percent of alpha generated for its investment in a hedge fund.”
The Year Ahead
The geopolitical events of 2016 had a relatively muted impact on financial markets, 2017 may well be different. During the last century equity bull markets have lasted an average of 97 months. The current bull market began in March 2009. This is month 82, we may still have some way to go, however, since WWII only one bull market has lasted longer – 149 months between 1987 and 2000. I believe we are in the later stages of a bull market which has been driven, even more than usually, by accommodative monetary policy. Hedge Funds and, Managed Futures strategies – which have languished over the last couple of years – will prove their mettle in the year ahead.
You can catch Colin Lloyd’s roundups on Macro and Hedge Fund performance every fortnight on Linear Talk. Watch interviews with interesting characters from the hedge fund world on Linear Talk in the Media tab. Download Colin’s PDF here