This content is from: Portfolio

Investors More Bullish on Hedge Funds Than the Managers

It looks like investors are bullish on hedge funds. Too bad you can’t say the same about the fund managers themselves.

It looks like investors are bullish on hedge funds. Too bad you can’t say the same about the fund managers themselves. According to the latest report from HFR, total assets under management grew to $1.917 by year-end, thanks to a $149 billion increase during the fourth-quarter. This exceeds the previous record increase of $140 billion in the second quarter of 2007.

As a result, total assets are just shy of the all-time of $1.93 trillion topped in the second quarter of 2008. Altogether, investors pumped in $13.1 billion in net new capital in the fourth quarter and $55.5 billion for the full year.

Meanwhile, there was a surge in new hedge fund launches last year, as the number of new fund offerings exceeded liquidations for the first time since 2007, according to HFR. Altogether, 935 new funds were created in 2010. According to HFR, 38 percent of the money that went into the new funds was earmarked for equity hedge funds, suggesting investors in these start-ups are willing to make a bigger bet on the stock market.

However, it does not look like equity hedge managers in general are as confident in the overall market’s prospects as the investors pouring money into equity hedge funds and other strategies.

A recent report from JPMorgan Chase estimates that hedge funds currently have a beta of 0.19. This is only at the midpoint between typical highs of 0.40 or so and lows of -0.3. JPMorgan analyst Thomas Lee stresses his firm’s calculation of hedge fund beta is based on data supplied by its global tactical asset allocation team.

Little wonder hedge funds have lagged the performance of the overall stock market. “This underperformance [is] amplified by the fact credit market performance has been flat, leaving equities as one of the few areas with meaningful upside,” the bank adds.

Lee thinks the continued rise in the stock market is going to pressure hedge funds to push beta towards prior levels of 0.40 or so. If he is right it could be yet another boost to the stock market.

However, if hedge funds don’t take on more risk by increasing their beta, investors pouring money into hedge funds may be surprised to see their favorite manager underperform the overall market if it continues to rise.

Even worse, if the managers start taking on more risk just as the markets peak and then tumble, then hedge funds will fare worse than the overall market in the downturn, just when investors finally warmed up to the asset class again.

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