20/06/17

Hedge-fund launches grow, in positive industry sign—but performance trails

The hedge-fund industry has been struggling for years amid weak performance relative to the broader market and a surge in the number of closures, but the tide may be starting to turn, reports MarketWatch.

There were 189 new hedge fund launches in the first quarter of 2017, according to data from Hedge Fund Research, up from the 153 that were launched in the fourth quarter of 2016. This marked the first quarter since the first three months of 2016 where the number of launches grew, a sign that the industry could be seeing some stabilization, although the number of closing funds continued to outpace the number of new ones.

The number of liquidations dropped to 259 in the first quarter, down from 275 on a sequential basis. The greater number of closures than launches meant that the total number of active funds dipped to 9,773 in the first quarter.

Investors have been moving away from hedge funds; in 2016, more than 1,000 funds closed down, the most of any year since the financial crisis, despite a U.S. stock market that generally rose throughout the year. The shift is part of a broader move to passive investing, where investors buy funds that simply track an index like the S&P 500. Data have repeatedly shown that not only is this form of investing vastly cheaper than the fees charged by hedge funds, but it produces much stronger results, especially over the long term, and particularly when fees are taken into account.

In May, the HFRI Fund Weighted Composite Index rose 0.5%, bringing its year-to-date gain to 3.5%. To compare, the S&P 500 SPX, +0.83%  rose 1.2% in May and is up 9.4% thus far in 2017.

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To be sure, fund performance depends on the holdings of the fund itself. The top 10% of funds gained an average of 14.1% in the first quarter (more than twice the 5.5% gain of the S&P), while the bottom 10 fell 7%.

Investors holding those top funds would have been rewarded, but the average fund heavily underperformed, and those results were made worse by fees. The average management fee was 1.47% in the first quarter (compared with 1.48% in the fourth quarter of 2016), while the average incentive fee was 17.3% (down from 17.4%). Such fees mean that a hedge-fund manager has to beat the market by a substantial margin in order for it to be a better choice than an index fund, which can be had for as little as 0.04%, or 97.3% cheaper than the average hedge fund—before the incentive fee further reduces profits by nearly a fifth.

The growth in launches comes at a time when the market could be entering an environment where fund managers have higher odds of beating the overall market. A particular hope for the industry is the view that individual securities will be less correlated than they have been in recent years, when the multiyear recovery from the financial crisis lifted stocks fairly broadly. Greater dispersion in performance will theoretically make it easier for managers to pick names that will do better than the overall market.

Recent data has supported this argument, with a majority of active managers beating their benchmark thus far in 2017, helped by their exposure to technology stocks.

Hedge-fund assets are on track to end the year with their seventh straight annual record. HFR estimated that assets would top out at $3.07 trillion in 2017, though that only reflects growth in the funds’ underlying assets—flows are expected to be negative for a second straight year, with $5.5 billion being pulled from the industry.

Assets were $3.02 trillion at the end of 2016, a year that saw more than $70 billion in hedge fund outflows.