Bad Year For Hedge Funds, But Money Should Still Flow

Hedge funds posted the fourth worst quarterly performance in industry history in the third quarter, but investors still plan to increase their commitments to the asset class.

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Institutional investors are less satisfied with their hedge funds thanks to this year’s struggling market. Little surprise, of course.

Nonetheless, they still plan to increase their commitments to the asset class.

This is the theme of a new study from Preqin, the London-based expert on anything related to the alternative investments industry.

A recent survey of over 1,000 institutional investors in hedge funds found that 40 percent of investors complained that their returns did not meet their expectations in 2011. This was similar to the proportion in 2008, when the global markets imploded and suffered from even more volatility than this year. Just 9 percent feel hedge funds exceeded expectations.

Indeed, we recently reported that many large hedge funds underperformed the market during the strong upward move in October. And many lag the widely followed benchmarks for the year. In fact, Hedge Fund Research, which compiles hedge fund performance data, reported that hedge funds posted the fourth worst quarterly performance in industry history in the third quarter, noting that uncertainty regarding the European sovereign debt crisis and weakening economic data contributed to volatility across equity, credit, commodities and currencies.

Yet, institutions still believe in the asset class over the long haul. One-fifth of those interviewed said their confidence in hedge funds has increased since 2010 while two-thirds (66 percent) said their confidence towards hedge funds had remained unchanged since 2010, Preqin reports.

And they are prepared to put their money where their confidence is. Just 9 percent plan to decrease their exposure to the asset class.

“Expectations may not have been met across the board for 2011, but those involved in the industry recognize that the challenging conditions experienced in worldwide markets have made life difficult, but not impossible, for absolute returns and consequently many investors remain confident in the ability of hedge funds to achieve their long-term portfolio objectives,” says Alex Jones, content producer for Preqin. “Although the industry can experience small scale knee-jerk redemptions in times of economic turmoil, investor sentiment towards the asset class remains generally positive.”

He cites, for example, John Paulson, whose redemptions were somewhat modest given the huge losses in some of his funds so far this year.

Meanwhile, the survey also found that just 20 percent of investors pledged to maintain current relationships only. Rather, 21 percent said they will consider new managers on an opportunistic basis while 10 percent will focus on adding new managers.

Jeff Vale, Chief Investment Officer at Infinity Capital Partners, LLC, an Atlanta-based alternative investment management firm, believe many investors are probably more unhappy with their long-only investments, so their hedge fund underperformance doesn’t look all that bad. Yet, their existing funds are still disappointing, so they are looking elsewhere to add to these holdings. “I would think this is a classic case of investors chasing good performance,” he adds.

HFR earlier reported that investors pumped a net $8.7 in new capital into hedge funds in the third quarter, the ninth straight quarter in which the industry has experienced net inflows. This brings year-to-date inflows to $70.1 billion, boosting industry-wide capital to $1.97 billion.

What are the five strategies most sought by institutional investors over the next 12 months? Number one is clearly long-short equity. This is somewhat surprising, given the asset class has struggled for the past two years or so.

Preqin found that Macro is the second most preferred strategy for new money in 2012, followed by commodity trading advisors (CTAs), Event-driven and Credit.

Jones also points that that although much has been made regarding the decline in funds of hedge funds over recent years, the multi-manager model remains a key part of the industry, favored by smaller and less experienced investors to gain access to the asset class. Many other investors are using a combination of funds of funds and single-manager funds to make their investments into hedge funds, he says.

He adds: “Competition for capital is higher than ever and therefore it is managers who are able to understand the institutional investor universe and market their offerings appropriately that will stand out and be most successful in attracting funds.”

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