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Private banks look to hedge funds as diversifiers

Private banks look to hedge funds as diversifiers

It ended 2017 with a bang but performance has been muted this year. Asia posted the largest declines in some months, but market conditions are still expected to stay favourable. This is hedge fund trading Asia-style.

There are many reasons to turn negative on hedge funds. But most private banks have included this investment fund as an important portfolio diversifier and alternative source of returns this year.

Deutsche Bank Wealth Management, for instance, has taken a positive view on discretionary macro strategies; a neutral-positive view on commodity trading advisor, event-driven, and equity market neutral strategies; and a neutral view on credit long-short and equity long-short strategies.

What’s more, under its alternatives asset allocation, DBS Private Bank is recommending both hedge funds and gold to its wealthy investors. On a three-month basis, the Singapore lender is neutral on hedge funds, but is overweight the asset class over the next 12 months.

Examining investor sentiments on a global scale, Credit Suisse’s latest mid-year hedge fund study quizzing 279 institutional investors, showed there is still continued strong appetite for hedge funds in the second half of 2018.

Representing $1.04 trillion in hedge fund investments, most of the end-investor inflows came from family offices (8%), followed by endowments and foundations (6%), pensions (7%), insurance (2%) and sovereign wealth funds (1%).

Under intermediaries, most of the hedge fund investments were generated from fund of hedge funds (28%), consultants (31%) asset managers (12%) seeders (1%) and private banks (4%).

Interestingly, the study showed that discretionary macro is the top strategy preference for the remainder of 2018.

Unlike last year, there is also more divergence in demand across equity sub-strategies, Credit Suisse said. It added that EMEA and Asia Pacific participants indicated a strong interest in environmental, social and governance investments.

While currently a challenging environment, investors look at Asia-Pacific and emerging markets as a longer-term opportunity.

Asia performance

In terms of asset growth, the $196.6 billion Asian hedge funds industry posted a modest growth of $2.1 billion in the first half of 2018, according to Eurekahedge, a Singapore-based hedge fund database provider.

However, if you take out the gains recorded in January, assets under management declined by $5.0 billion. This was largely due to performance driven losses, points out Mohammed Hassan, the company’s head analyst for hedge fund research and indexation. 

‘2018 has seen a strong pull-back in returns after solid gains in 2017,’ Hassan said. ‘The Eurekahedge Asian Hedge Fund Index returned -1.17% in 2018 June year-to-date versus 17.09% in 2017.

‘Rising US yields and a stronger dollar combined with the US-China trade war has hurt sentiment, with Greater China-focused hedge funds being the big casualty, down -0.28% in 2018 June year-to-date versus 29.89% in 2017,’ he continued.

‘In June alone, Greater China hedge funds lost 4.37%. On the whole Asian mandates have still managed to outperform underlying markets for the most part.’

Hassan adds that equity long-short strategies have been the biggest casualty this year, given the directional exposure to underlying Asian markets.

Macro strategies could be interesting as central bank policy normalizes, but their returns over the past couple of years have been quite unappealing.

Developed market mandates, on the other hand, have done relatively better compared with emerging markets this year, but performance varies when you look at the top quartiles for each regional mandate.

‘Moreover, performance also varies depending on the strategy. For example, Asian event-driven managers have done better compared with Asian equity long-short managers in 2018,’ he said.

Manager selection

Performance variation across and within hedge fund regional and strategic mandates makes it all the more important to identify the right managers.

Within the Asian hedge fund space this year, Hassan said, almost 44% of the managers posted positive returns, while 56% are in the red.

‘This is not to imply the 56% are necessarily poor performers, but different strategies respond differently to underlying market conditions,’ he said.

Depending on what private banks are looking for, the executive recommends wealth managers choose a manager with a clear and consistent edge.

‘Downside protection is very important for most clients,’ said Hassan. ‘You don’t want to be paying the higher performance fees compared to passive products and then see your investment underperform or even track the market portfolio.’

‘Moreover, commodity trading advisors (CTA) have small positive to small negative correlations to other hedge fund strategies, so from the portfolio perspective they can add value.

‘The challenge here is to look for managers that provide a differentiated stream of returns net of fees. The CTA space saw tremendous growth in fund population post-2008; the average CTA gained 19.43% in 2008 at a time when underlying markets declined by over 50%.

‘It’s easier to find many quality long-short managers in Asia as opposed to those deploying relative value-market neutral strategies.’

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