JP Morgan released the results from its annual investor survey of hedge fund investors this week. It provides a good overview of what strategies investors liked and disliked as well as their expectations for 2015. It is always useful to compare what investors have done with what actually happened.
The survey suggests the main reason for investing in hedge funds is again alpha generation. It is assumed that managers have special skill and that they can exploit to generate higher returns. There may be skill, but perhaps the number two reason, diversification, is the better long-run play for investing in hedge funds.
The two most important criteria beyond skill as measured by pedigree and track record is risk management and communication. The demands from investors are simple; delivery return, control the risk, and tell investor what you are doing.
It is interesting that investor want the skill of an alpha generator but are afraid of the crowded trades. Show skill but do not be a copy-cat with your behavior. I find it interesting that investors want uniqueness but not too much deviation in behavior from the norm, and do not have too much conviction by taking excessive risk. It is hard to show skill if you do not take active bets that are bigger than average.
Most investors increased exposure to long/short equity fundamental managers last year. Although hedge funds are supposed to serve as alternatives to traditional assets, investors have a comfort zone that is still tied to equity investing. The long/short manager will have a lower beta than the market but is supposed to make extra alpha. In a rising market, investors are likely to be disappointed by this scheme unless risk is reduced.
Investors have been disappointed with global macro. In the growing uncertainty this year, global macro was not able to deliver exceptional returns. The same has been the case with credit strategies. CTA's saw the most dramatic change in the second half of the year.
The anticipated best performing strategy is consistent with where investors placed their money in 2014 - long/short equity and event driven. Only 9% of respondent think managed futures will do best in 2015 even after coming off a good year.
The poorest performing strategy in 2015 is suppose dot be commodity investing. Investors expect the poor trend in performance to continue. The next worst strategies include credit and fixed income arbitrage. On a directional basis, this is likely but higher volatility and changes in direction may allow the skill manager to profit.
The good versus bad must be weighed and the net exposure actually shows that managed futures is supposed to see the greatest net increase in exposure for 2015. It is not considered to be the best, but investors want more exposure to this diversified strategy. This increase will come at the expense of credit strategies and fund of funds.
We look forward to seeing if hedge fund investors are good at picking winners and loser for 2015. Early results suggest that they may be on to something.
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