Flash talk by Nat Kellogg, CFA at Marquette’s 2015 Investment Symposium on the future of hedge fund allocations.
Hedge Funds – Still a Good Idea?
2015 Investment Symposium flash talk session
Topic Tags: Hedge Funds
Do Liquid Alternatives Deserve the Hype?
Liquid alternative assets, as defined by Morningstar, have continued to grow since 2009 and by the end of 2014, reached nearly $158 billion, up 11% from the previous year. The top 2014 fund flows within Morningstar’s liquid alternative category were concentrated across multi-alternatives (+$9.8B), long/short equity (+$6.5B), and managed futures strategies (+$2.3B).
Liquid alternative1 assets, as defined by Morningstar, have continued to grow since 2009 and by the end of 2014, reached nearly $158 billion, up 11% from the previous year. The top 2014 fund flows within Morningstar’s liquid alternative category were concentrated across multi-alternatives (+$9.8B), long/short equity (+$6.5B), and managed futures strategies (+$2.3B). Additionally, multi-alternative flows have already totaled $1 billion in the first month of 2015, continuing to lead all other categories.
Before jumping on the bandwagon, it is important to take a step back and analyze how some of the liquid alternative strategies have performed compared to their private counterparts. Although not an exact apples-to-apples comparison, this week’s chart of the week compares the growth of $1 since January 2000 of the HFR equity hedge index (private) vs. the Morningstar long/short category (liquid). Interestingly, while the liquid long/short equity strategies outperformed private HFR equity hedge from early 2001 through mid-2003, private funds have beaten their liquid counterparts by a significant margin over the long run. Although liquid alternatives offer an attractive liquidity profile, they come with all the restrictions of a 40 Act mutual fund which limit illiquid holdings and leverage. When it comes to investing in alternative strategies, this is one reason we believe that private vehicles are most appropriate for institutional investors.
1Liquid alternatives encompass non-traditional investment strategies or asset classes (beyond equities and bonds) such as REITs, MLPs, commodities, currencies, distressed debt, or hedge fund strategies in a mutual fund format.
2015 Market Preview
January 2015
Similar to previous years, we offer our annual market preview newsletter. Each year presents new challenges to our clients, and 2015 is no different: U.S. equities are at all-time highs, uncertainty reigns for international equities, and to everyone’s surprise, interest rates fell dramatically in 2014…but are poised to rise from historic lows over the next year. In the alternative space, real estate remains a solid contributor to portfolio returns, and private equity delivered on return expectations, though dry powder is on the rise. Hedge fund results were mixed, but have shown to add value in past rising interest rate environments. Further macroeconomic items that bear watching for their potential impact on capital markets include the precipitous fall in oil prices, the strengthening U.S. dollar, job growth, and international conflicts.
Hedge Funds vs. the Equity Market
Recently, the California Public Employees’ Retirement System (CalPERS) announced its decision to completely shutter its hedge fund program. As a result of this news, investors have been asking whether hedge funds still deserve a spot in their portfolios.
Recently, the California Public Employees’ Retirement System (CalPERS) announced its decision to completely shutter its hedge fund program. As a result of this news, investors have been asking whether hedge funds still deserve a spot in their portfolios. In this week’s Chart of the Week, we examine the efficacy of hedge funds compared to equity markets over the last 25 years. To do this, we compare the rolling 3-year Sharpe ratios of hedge funds (using the HFRI Fund Weighted Composite as a proxy) and equity markets (using the S&P 500 as a proxy). As a reminder, Sharpe ratios are a measure of risk-adjusted return, so a higher score represents a more attractive risk profile.
A comparison of the two indices suggests that recent hedge fund performance has been disappointing as the S&P 500 has delivered higher risk-adjusted returns over the last few years. However, most investors who have added hedge funds to their portfolios have done so to add diversification and new sources of alpha to their portfolios, so a comparison based on returns may not be entirely fair when comparing the equity market to hedge funds. Moreover, it is critical to note that the last five years have featured an impressive bull market that will naturally outpace hedge funds, which endeavor to create more attractive risk-adjusted returns by utilizing various strategies designed to limit downside risk, but also limit upside potential in times of bull markets.
So while hedge funds may surrender some return in times of significant market rallies, they can be expected to offer protection from market corrections, which are a part of every market cycle. Over the long term, the graph shows that hedge funds have indeed delivered higher risk-adjusted returns, in spite of the recent dip. Given the long-term cyclical nature of the market, when equities exhibit a correction, hedge funds should see a shift in relative performance, and once again demonstrate their utility to investors.
Growth of Liquid Alternatives
This week’s chart looks at the recent fund flows and the trailing twelve month (“TTM”) percentage growth rate of liquid alternatives as of March 31, 2014. Over the past decade, private investment managers, traditionally associated with less liquid investments such as hedge funds, private equity, and real estate, have expanded their investment focus towards the creation of liquid alternative products that comply with the 1940 Investment Company Act in order to meet the demands of the rapidly growing defined contribution market.
This week’s chart looks at the recent fund flows and the trailing twelve-month (“TTM”) percentage growth rate of liquid alternatives as of March 31, 2014. Over the past decade, private investment managers, traditionally associated with less liquid investments such as hedge funds, private equity, and real estate, have expanded their investment focus towards the creation of liquid alternative products that comply with the 1940 Investment Company Act in order to meet the demands of the rapidly growing defined contribution market.
Within the open-ended mutual fund universe, liquid alternatives have once again topped all other asset classes with the highest organic growth rate over the TTM period, up 39.5% as of March 31, 2014. Although this growth rate is impressive, liquid alternative assets only represent 1.3% ($149B) of the U.S. mutual fund universe, which has over $11 trillion in assets.
As the trend toward liquid alternatives continues to grow, investors should consider the potential implications and effectiveness of the newly designed strategies. ’40 Act funds must comply with restrictions not required by traditional hedge funds such as leverage limits, short-selling, and liquidity. In addition, the standard 1.5% and 20% hedge fund fee structure has to be adjusted within the ’40 Act universe; currently, the average management fee for liquid alternative funds is around 1.5%. Since the significant rise in the formation of liquid alternative products has taken off within the past few years, investors should be cautious before diving into the space as the next decade will be a testing ground for these strategies as to whether or not they deliver on their performance expectations, in terms of both return and diversification.
2014 Market Preview
January 2014
Similar to previous years, we present our annual market preview newsletter. Each year presents new challenges to our clients, and 2014 is no different: We are coming off a banner year for U.S. equities, low interest rates continue to stymie fixed income investors, and while developed market equities enjoyed a strong 2013, emerging market stocks sputtered. In the alternative space, real estate and hedge funds proved accretive to portfolio returns, while growing dry powder in the private equity space is starting to raise a few eyebrows.
Emerging Trends in Alternative Asset Classes
2013 Marquette Investment Symposium session
In this presentation from our 2013 Investment Symposium, we explore various emerging trends in the alternatives space, including low volatility equity, tail risk, managed futures, gold, MLPs, GTAA, risk parity, farmland, direct lending, and opportunistic credit.
Investment Symposium 2013
Recorded September 13, 2013
Please contact us for access to this video.
Hedged Equity: What Happened to the Alpha?
Late January 2012 Investment Perspectives
Coming out of a phenomenal period of relative performance during the tech boom and bust, hedged equity performance declined relative to the S&P 500 during the mid 2000’s.
However, absolute returns were still strong in risk adjusted terms, and hedged equity offered significant downside protection in 2008. While hedged equity trailed as the stock market rebounded in 2009, returns were high and trailing three-year performance strong. Lately though, even as hedged equity hedge funds have continued to offer risk reduction in terms of lower volatility, weak hedge fund performance has prompted increasing investor concern.
Hedge Fund Position Paper
The first of a two part series, this paper provides an overview of the hedge fund asset class as well as recommendations and allocation guidance.
This paper is meant to provide an overview of the hedge fund asset class, an analysis of the qualitative and quantitative factors that should be used to asses hedge funds and determine their appropriate use in a portfolio, and lay-out and justify Marquette Associates’ position on the use of hedge funds in client portfolios. Recommendations as well as guidance towards making an allocation to the asset class are also included.