The hedge fund industry is showing signs of life. Flows are not overwhelmingly positive, but positive enough in May, and in enough months of 2017 to indicate that 2016 may have been simply a reaction to a difficult time, and not an utter disdain for the structures. That said, there are some areas of concern mixed in with the positivity.

Macro managers should hope that investors’ reactions to managed futures performance will not carry over to their own recent underperformance. The industry needs investor confidence in the discretionary talents within the macro universe. Performance has been too varied within the long/short space for new allocations to outpace redemptions, and multi-strategy fund flows while positive in May, have only just turned positive for the year. What is clear is that investors will not ignore good returns, or products that may help mitigate or even benefit from apparent risks in global markets.

Highlights

• Investors flows were positive in May. An estimated $10.5 billion was added, bringing YTD inflows to $23.3 billion.
• Macro funds continue to attract assets, but recent losses from its largest constituents may impact sentiment.
• Investors removed money from managed futures funds in May.
• Active credit exposure appears to once again be attractive to investors.
• Allocations to multi-strategy funds jumped in May.

Allocations to Hedge Funds Resumed in May

Investor flow was firmly positive in May. Investors added an estimated $10.52 billion during the month, bringing YTD flows to $23.32 billion. Total industry AUM sits at $3.130 trillion.

Key Points

• There appears to be reasonable levels of interest in hedge funds in 2017.
  After a positive Q1, despite an overhang of redemptions in January, investor flows into hedge funds paused in April, but data from May indicates investors have once again resumed healthy allocations into the industry.
• Investor allocations to macro strategies continued in May, but recent performance losses may test resolve.
  Macro strategies again received net inflows in May, the fifth consecutive month of new money coming in. The segment is leading the industry for flows in 2017, but it is also lagging the industry in terms of performance. After the last two months of negative returns, the ten largest reporting funds are underperforming most other segments of the industry.
• Investor sentiment turns negative for managed futures funds.
  It has been an up-and-down ride for managed futures investors performance-wise, and for managed futures funds flows-wise. The segment attracted investors in 2016 after relatively strong returns from its largest managers in 2015, but that interest waned at the end of the year. Somewhat surprisingly given performance, investors returned in Q1 2017, likely seeking alternative markets and systematically generated exposures. But as performance has continued to lag the industry, investor sentiment appears to have shifted negative in May.
• Multi-strategy fund flows rebounded in May.
  This segment has been under pressure from investors since mid-2016 due to a string of sub-par returns which began in mid-2015, and non-performance related issues facing one of its largest constituents. More recently, performance has been quite strong. Only two negative months in the last fifteen, and six in a row ending May 2017 appears to have settled some investors’ nerves.
• Investors keep allocating to commodity funds.
  Commodity strategies are the single worst performing segment of the industry in 2017, but despite performance issues investors resumed allocating to commodity funds in May. This is surprising.
• Active credit exposure is attractive again.
  Credit hedge funds experienced elevated losses in late 2014, and then again in the second half of 2016. For a segment which received a large amount of assets post financial crisis, and as European sovereigns/banks began to show weakness, these losses appeared to break investor’s sentiment. Since mid-2016 returns have stabilized and performance has generally been good, and investors appear to have warmed to the segment once again. May’s elevated inflows are the second consecutive month, and fourth in the last five where allocations have outpaced redemptions. eVestment’s traditional data tells a similar story of institutional interest in fixed income exposure.
• Past returns continue to be a driver of 2017 allocations. Where returns have been mediocre, size is the differentiator.
  Across just about every major segment, products which produced firmly positive returns in the prior year appear to have had little trouble raising capital, while those with losses have difficulty holding on to capital. Year-to-date 2017, investors have added an estimated $46.3 billion into funds which returned greater than 5% in 2016, while removing $30.4 billion from those who lost money last year. For funds which returned in the 0-5% range, large funds have gained $5.2 billion in net new assets, while smaller funds have had redemptions of $2.4 billion. The lone exception to the theme are managed futures funds, whose flows in general have been an anomaly up until May. Managed futures funds of all segments and sizes have received new assets in 2017, except for small underperformers. That combination appears unacceptable to investors.

Final Strategy Thoughts:

The hedge fund industry is showing signs of life. Flows are not overwhelmingly positive, but positive enough in enough months of 2017 to indicate 2016 may have been simply a reaction to a difficult time, and not necessarily an utter disdain for the structures. That said, there are some areas of concern mixed in with the positivity. First, macro managers should hope that investors’ reactions to managed futures performance will not carry over to their own recent underperformance. The industry needs investor confidence in the discretionary talents within the macro universe. Performance has been too varied within the long/short space for new allocations to outpace redemptions, and multi-strategy fund flows while positive in May, have only just turned positive for the year. What is clear is that investors will not ignore good returns, or products that may help mitigate or even benefit from apparent risks in global markets.

Despite outsized returns, investors are not allocating to EM hedge funds with any sort of enthusiasm

Key Points

• Emerging market hedge fund flows were near flat in May, and are negative for 2017.
  Despite five consecutive months where returns from EM strategies have been double that of non-EM strategies, investor flows have been mixed. There are products gaining assets, primarily larger funds which performed very well in the second half of 2016, but those targeted allocations are being offset by redemptions from others.
• China-focused fund flows showing signs of life.
  While the story for China-focused products has recently been of positive returns and negative flows, barring targeted allocations to specific products, reporting funds in May are showing that while the targeted allocations continue, money is trickling in to others. The majority of China-focused funds saw inflows in May, something we have not seen since 2015.

Article by eVestment