Bye-bye beta-driven opportunities, hello diversity for hedge fund investors

According to the latest figures and accompanying analysis from Credit Suisse Tremont’s April Hedge Fund Index report (click here to download), hedgies are on fire, with collective returns of 3.1% in the first quarter, outperforming traditional equity and bond indices and moving them further towards recouping financial crisis-induced losses.
As of the end of March, funds had earned back more than 90% of losses made in 2008, according to the results complied from the group’s analysis of more than 5,000 funds. Those following event-driven strategies – profiting from things like merger and acquisition activity, bankruptcies and corporate restructurings – were the top performers, posting an average return of 4.8%.
Of particular interest in the report, however, was that while the majority of hedge funds posted positive first-quarter returns, beta-driven investment opportunities generated by the market rallies of 2009 have become scarcer, while most equity market performance expectations remain below their 2009 levels.
“As a result, we believe that manager returns are currently less driven by system­atic or beta risks than they have been in the last five years,” the report said.
This argument is illustrated in the chart below, which shows the 12-month rolling beta of the Broad Index to the MSCI World equity index. On closer look, it can be seen that the beta of hedge funds to global equity markets has continuously trended down since its spike in 2008-2009 and is now at its lowest level since 2004.

Source: Credit Suisse Tremont

The result, according to CS Tremont, is a new wave of diverse strategies that aim to capitalize on distinctive market opportunities, which in turn have allowed hedge funds to produce stable and positive returns irrespective of equity market movements through the first quarter.
Anecdotally, this is true: contrary to before the crisis when the vast majority of new strategies were long/short, a quick glance at BarclayHedge’s new fund launches shows a variety of strategies ranging from fixed-income diversified to distressed, options-focused and even metals and mining.
Event Driven is a particular example, according to the report, where gains were largely gener­ated through exposures to event driven distressed credit opportunities, where the majority of managers’ positions were related to singular market events such as bankruptcy or restructuring situations. Event Driven managers have also taken steps to monetize long equity exposures that have reached price targets while restructuring their remaining exposures to reduce market risk.
“Many believe that expectations for this sector continue to be favorable for the remainder of 2010 as credit opportunities could continue to generate alpha,” the report said. “Some also feel that Merger Arbitrage-focused managers may be in a beneficial position going forward as an increasing number of global mergers and acquisitions, as well as corporate consolidations and restructur­ings, could provide an increased number of prospective deals.”
And the line between hedge funds and other types of retail investment products continues to blur, with hedge fund managers opening their doors to new types of inves­tors through the launch of retail vehicles such as UCITS III funds, exchange-traded products and mutual funds, according to CS Tremont. (Click here for AllAboutAlpha’s recent coverage of UCITS-focused hedge funds).
The report further noted that accompanying better returns was also improved liquidity conditions, particularly with respect to “impaired” assets, and a rebound in asset flows. CS Tremont estimates total assets under management globally at around $1.5 trillion, with expectations of potentially breaching the $2 trillion mark before the end of 2010 (see two additional charts from the survey below).

Source: Credit Suisse Tremont

Source: Credit Suisse Tremont

It’s all yet another feather in the cap for an industry still trying to convince institutions and individuals alike that alternative strategies were – and still are –a good thing, even though they collectively lost close to 20% during the Great Recession.  It’s one thing to produce great returns in bull markets, and not-so-bad returns in bear markets. It’s quite something else convincing investors that losing 20% – and having access to your money cut off – was a lot better than losing 40%.