It’s no secret that 2015 was a tough year for hedge funds. After a harsh summer marked by volatility in global markets, some hedge funds produced their worst performance since 2008, contributing to a 1.12 percent decline in Chicago-based data tracker Hedge Fund Research’s HFRI Fund Weighted Composite Index for the year.
The fund-of-funds universe reflected much of that difficulty. The HFRI Fund of Funds Composite Index, a widely followed industry benchmark, fell 0.23 percent last year, while total assets managed by the global fund-of-funds industry fell by $12 billion, according to London-based alternatives research firm Preqin. The world’s largest 50 fund-of-funds firms collectively managed nearly $578 billion at the end of 2015, representing just over 70 percent of the sector, according to Alpha’s latest Fund of Funds 50 ranking. That’s up less than 1 percent from the previous year’s total of $574 billion.
But indexes and industry outflows don’t tell the whole story of what happened to hedge funds last year. Beyond the numerous macroeconomic events that roiled markets, fund-of-funds managers tell Alpha that dispersion among single-manager performance was the highest in some time, with clear winners and losers. “Manager selection was much more important last year than in most years,” says Jane Buchan, CEO of Irvine, California–based Pacific Alternative Asset Management Co. (PAAMCO).
Among the firms that got it right last year is New York–based Blackstone Alternative Asset Management (BAAM), which appears for the fifth consecutive time atop the annual ranking. Despite industry outflows and macroeconomic meltdowns last year, BAAM’s assets under management grew from $63 billion the previous year to more than $69 billion at the start of 2016. Both Stamford, Connecticut–based UBS Hedge Fund Solutions and New York’s Goldman Sachs Asset Management managed to hang onto their previous rankings of No. 2 and No. 3, with $33.9 billion and $28.9 billion in assets under management, respectively. London’s HSBC Alternative Investments climbed back toward the top at No. 4, with $27.2 billion in assets, after falling two spots to No. 5 last year, while Chicago-based Grosvenor Capital Management fell to No. 5, with $26.8 billion in assets.
Despite poor industrywide performance, some firms got bigger. The highest-growth firm (in percentage terms) from last year’s ranking, New York’s Arden Asset Management, was acquired at the end of 2015 by Aberdeen Asset Management, in a move intended to expand the London-based firm’s global alternatives platform. The newly renamed firm retains Arden’s No. 14 spot. Switzerland’s LGT Capital Partners jumped nine spots and gained $2 billion in assets to land at No. 24 from its No. 33 ranking last year. Stamford-based Titan Advisors also moved up nine spots, from No. 45 to No. 36, and gained $1.3 billion in assets. At the other end of the spectrum is Paris-based Amundi Alternative Investments, which dropped 12 places, from No. 20 to No. 32, and lost $1.8 billion in assets.
A fuller picture of 2015 emerges at the strategy level, where there was nearly universal agreement among fund-of-funds managers on what worked and what didn’t. Shorter-term, more liquid, systematic strategies outperformed, as did long-short equity strategies. Meanwhile, event-driven and activist strategies got hit unexpectedly hard when a number of high-profile deals fell through and a pair of popular hedge fund activist targets disclosed major accounting problems.
Event-driven managers thought the flurry of M&A activity would be a boon and were caught off guard when newsworthy mergers were derailed by new government interventions. And managers who went all-in on the fast-moving stocks of SunEdison and Valeant Pharmaceuticals International paid a steep price when those companies’ accounting problems surfaced, causing shares in both businesses to plummet. (SunEdison has since filed for Chapter 11 bankruptcy protection.)
Many other managers suffered last year because of macroeconomic events that created volatile conditions and greatly influenced global markets. In January the Swiss National Bank abruptly lifted its cap on the Swiss franc — a move that shocked the markets and elevated the currency’s value, causing many macro managers with short positions to sustain losses. In July, Greece’s almost decadelong recession came to a head when the struggling country agreed to a €86 billion ($95 billion) bailout from the European Commission, European Central Bank and International Monetary Fund. This was another unexpected move from the euro zone, which hedge funds had bet on to flourish after ECB president Mario Draghi announced his €1.1 trillion quantitative easing program to spur growth in the region.
There was even more bad news in the second half of the year. In August, China’s stock market crashed when the pace of growth for the world’s second-largest economy was revealed to be much slower than hedge funds and other investors expected, raising concerns about the country’s economic health. Commodities like oil were greatly affected by China’s shifting economy, which caught a number of hedge funds in the wrong position. European funds of funds suffered the most outflows last year, with 60 percent of fund liquidations coming from Europe-based vehicles.
Among the positive-performing hedge funds, one common theme emerged: the rise of the machines. “I think the top quant strategies have outperformed the top discretionary strategies,” says Gideon Berger, head of risk management and technology for the Hedge Fund Solutions Group at BAAM and chairman of the firm’s investment committee. Berger, who holds a Ph.D. in computer science from New York University, thinks it’s unlikely that people will get better at buying and selling securities, but he believes computers will. “It has definitely informed our decision to increase allocations to quant strategies,” he says.
Morgan Stanley Alternative Investment Partners (AIP), No. 7, with $22.4 billion in assets, also benefited from its use of quantitative strategies, including equity statistical arbitrage and systematic macro strategies that employ shorter time frames, according to portfolio manager Mark van der Zwan. “However, we saw very few underlying hedge fund strategies generate outsize positive returns,” he says. Ultimately, many computer-driven strategies were better able to manage the risk factors that posed challenges to fundamental managers last year, he adds.
For Laurence Russian and his team at Greenwich, Connecticut–based long-short specialist ABS Investment Management, 2015 was a decent year. “When we dissect the numbers, performance for us was driven by a mix of stock-specific alpha as well as thematic and sector positions,” says Russian, whose firm is No. 39, with $5.2 billion in assets.
Manager skill in selecting stocks was of great significance last year. Russian says he and his ABS co-founders, Alain De Coster and Guilherme Valle, have been investing in long-short equity for 20 years and tend to like “differentiated, off-the-run managers.” In an environment where many larger hedge fund managers crowded into popular stocks, ABS avoided big losses because the firm wasn’t invested in the big funds that suffered hefty losses.
Chapel Hill, North Carolina–based Morgan Creek Capital Management, No. 47 with $3.2 billion in assets, ended the year on a positive note in its Global Equity Long/Short Institutional Fund, and though CEO Mark Yusko says he’s “not going to do handstands for almost 3 percent,” he’s happy to beat the market. The fund has done well since the firm added its Morgan Creek Direct strategy in 2013; this portfolio of direct investments in equities made up approximately 20 percent of assets in the Global Equity Long/Short fund in 2015. The direct portfolio helped the fund deliver double-digit returns in 2013 and 2014, and kept it above water throughout last year’s challenging market.
Overwhelmingly, event-driven funds and managers posted poor performance, particularly in the distressed sector. HFRI’s distressed index fell 8.14 percent for the year. Some firms, including AIP, managed to avoid a major negative impact in that strategy, remaining underweight given low default rates and distressed ratios in the U.S. and Europe in early 2015, combined with deteriorating liquidity in the secondary market. A few firms suggest their overall performance was saved by strategies, like distressed, that they chose not to invest heavily in at the outset.
Christine Johnson, head of alternatives at New York–based AllianceBernstein (No. 25, $9 billion), said distressed strategies proved to be the most challenging of 2015. “The other interesting thing we’ve seen over the past year is that our most liquid offerings, because they don’t have distressed and activist managers, have performed better,” Johnson says.
In the fall many hedge fund managers who specialize in debt were hit especially hard by declining oil prices and energy sector instability. One fund-of-funds manager mentions energy broadly as a distressed-situation land mine that a lot of hedge funds were involved in that his firm consciously avoided, mostly because there are still many questions in the sector that need to be answered. The future of fossil fuels and renewables, or green energy, is still uncertain.
So far this year, macroeconomic factors continue to be a concern, particularly with low-growth and zero-bound or negative interest rates in the developed world. China’s future looks unstable, and so does the energy sector: Oil traded at a low of $26.55 a barrel in January before rebounding above $40 in April. ECB president Draghi continues to work toward a euro zone recovery, but this summer British citizens will decide whether they want to continue to be included in the European Union. The outcome of the U.S. presidential election in November may also shift investor sentiment in the second half of the year.
“This is the worst start to the year that we have witnessed in a long time,” says J. Tomilson Hill, CEO and president of BAAM. Hedge Fund Research reported that hedge fund outflows in the first quarter of 2016 were the largest since 2009: $15.1 billion in total and $2.9 billion in funds of funds. Others note that positive trends from 2015 seem to have reversed in the first quarter. For many, though, some of the same problems from 2015 persist: overcrowded trades, central bank uncertainty, single-stock dispersion.
Hill and his colleagues at BAAM are a little more optimistic. “Sometimes a bit of a washing out creates a lot of opportunity,” risk management and technology chief Berger says.
