Investors Vote With Their Money In Favor Of Private Capital Hybrid Hedge Funds

It’s no secret that investors have been disappointed with hedge fund performance in recent years. As a group, hedge funds again underperformed the major stock market indices during the fourth quarter, although, as with anything else, there are outliers that posted tremendous fourth-quarter performances.

However, when we look at investor flows during the quarter, it becomes quite clear that investors aren’t giving up on the hedge fund model entirely. Instead, they’re showing a clear preference for funds with a hybrid model that includes some exposure to the private markets.

A positive quarter for hedge funds

In his fourth-quarter update for Citco, Declan Quilligan reports another solid quarter for the hedge fund industry, with all but one strategy posting a positive return and all size categories generating positive results.

The overall weighted average return for the hedge fund industry as a whole stood at 1.52%. However, the S&P 500 returned 10.44% for the fourth quarter, demonstrating the hedge fund industry’s continuing inability to outperform the roaring U.S. equity markets since the global financial crisis.

The fourth-quarter return recorded by Citco was an improvement from the previous quarter’s 1.15% return but significantly lagged behind the first- and second-quarter returns of 8.25% and 6%, respectively.

Quilligan notes that there was a significant number of outliers during the third quarter as the dispersion between the top and bottom funds was quite wide. However, the fourth quarter brought a significant narrowing of this gap as most funds reported similar mean and median returns.

More than 60% of hedge funds delivered positive annual returns in the fourth quarter, only slightly ahead of the 59% recorded in the previous quarter. However, the fourth-quarter number was below those of previous quarters.

Citco found that the dispersion in returns between the top 90th percentile of funds and the bottom 10th percentile of funds was 17.3% for the fourth quarter, a significant increase from the previous quarter’s reading of 12.49%.

Returns by strategy and size

Multi-strategy funds recorded the strongest performance at 2.54%, while global macro funds trailed close behind with a 2.33% return, followed by commodities at 2.19%. On the other hand, event-driven funds had the worst performance with a return of -0.39%, the only primary hedge fund strategy to post a negative return for the fourth quarter.

Of note, there was a meaningful difference between the median and weighted average returns by strategy. For example, while multi-strategy funds had the best weighted average return, they were the second-worst according to median return at 0.7%. Equity strategies had a median return of 2.17%—the highest of all the strategies—compared to its weighted average return of 0.87%.

Citco found that the largest funds continued to outperform their smaller peers during the fourth quarter, just as they had the rest of the year. Funds with more than $3 billion in assets under administration were the top performers with a return of 1.86%, followed by funds with between $1 billion and $3 billion, which returned 1.67%.

The size with the weakest weighted average return during Q4 was funds with between $200 million and $500 million in assets under management, with a return of 0.34%. Next up were funds with less than $200 million at 0.72% and then funds with $500 million to $1 billion at 0.77%.

On a median return basis, funds with over $3 billion in assets again led the way with a return of 3.85%, although funds with $200 million to $500 million were in second place at 1.64%. The weakest size category on median return was funds with $1 billion to $3 billion in assets, with a median return of 0.52%.

Trading volumes

Quilligan also looked at trends in trading volumes during the fourth quarter. He found that volumes continued to increase across Citco’s clients during the quarter to reach a new all-time high, even as he observed a return to cyclical patterns similar to those seen during the summer months.

According to Citco, trading volumes rose steadily from September into October amid declining volatility following its spike late in the third quarter. As the third-quarter volatility eased, the markets shifted into deploying futures and options on commodities, indices and interest rates. As volatility stabilized, fixed income volumes, especially credit default and interest rate swaps, plunged 21% following the spike in previous months.

In November, Citco picked up another 4.9% month-over-month increase in trading volumes among its clients. Market events triggered a sharp increase in volatility in late November and early December. Equity trading volumes peaked while equity swaps rose 10%, commodity futures climbed 12.6%, and IR futures surged 35.8%. Those were the largest increases recorded in high-frequency trading strategies.

In December, Citco found a significant deviation from previous Decembers in trading volumes among its clients. The firm recorded a 24% year-over-year increase in volumes, marking a stark contrast with the other normal patterns observed during the month. The sharp increase made the fourth quarter the busiest on record since the previous spike, correlating with the recent choppy volatility.

Citco found a significant increase in trading volumes until December 16. At that point, trading slowed as the year came to a close. Eequity and equity swap/ CFD volumes were the highest, as expected at that time of the year, but he also observed increases in trading of futures on indices, rates and currencies.

Investor flows

The fourth quarter brought a continuation of previous investor flow trends among funds on the Citco platform, which recorded net positive inflows for October and November, followed by net outflows for December.

Overall, investors injected $5.7 billion into hedge funds served by Citco during the fourth quarter, including net inflows of $7.2 billion and $7.1 billion for October and November, respectively. Citco-administered funds recorded $8.6 billion in net outflows for December.

The largest chunk of the quarterly inflows went to funds with $5 billion to $10 billion in assets under management, at $3.3 billion. Funds with over $10 billion and those with between $1 billion and $5 billion also received “healthy” levels of inflows in Q4. On the other hand, funds with less than $1 billion in assets—the only category to see negative flows—recorded outflows of $2 billion.

According to strategy, private capital hybrid funds racked out net inflows of $11.4 billion during the fourth quarter, making that strategy the most popular by far. Multi-strategy hedge funds recorded $2.7 billion in outflows, while equity funds saw $3.1 billion in net outflows for the quarter. All other hedge fund strategies had marginal net outflows or inflows for Q4.

Michelle Jones of ValueWalk contributed to this report.