Welcome to Sharpe Thoughts (previously named Uncorrelated), a monthly newsletter produced by MJ Hudson’s Hedge Fund Team.
It would be rash, indeed, to put one’s name to any sort of predictions about what to expect in the course of this year, so don’t expect any here! What we can say, however, is that, based on our work with clients in 2018, there were a few trends emerging which we think may have an impact on what we might expect to see this year – past results being no indicator of future direction as we all know!
2019 promises to be a year of managing expectations. The Bank of England got in early with its forecasts and if these are to be believed, we are in for the slowest year since 2009. Amid an on-going trade dispute with the US and weakening domestic demand, China has revised its economic forecast for 2019 and Germany, Europe’s largest economy, is sliding into recession, on the back of falling industrial output.
Against this backdrop, we anticipate more discussions around redemption, restructurings and liquidity management.
It’s not all doom and gloom however, we also expect this to throw up new opportunities with activist and merger arbitrage strategies doing well along with an increased appetite from investors for non-correlated investments, in everything from distressed debt, niche credit and litigation funds to cannaboids.
There is also a renewed interest in discretionary macro managers. There is continued pressure on generalist equity managers in favour of sector specialists and market neutral managers, including quantitative approaches.
Family offices will continue to be interested observers of (and occasional investors in) hedge funds.
Brexit management will remain a consideration for UK hedge fund managers but more importantly, so will Corbyn risk.
2018 continued the fee compression of recent years. We don’t see any reason for that to change in 2019; if anything, we expect to see continuing pressure from investors forcing managers to innovate, when it comes to fees. We saw a range of variations to the 2/20 model last year, with one of themes being the trade-off between lower or no management fees and higher, performance based fees.
Another theme in fee consideration is that, despite the average fee compression in 2018, investors who paid some of the highest fees also obtained some of the highest net returns. This is partly skewed by certain large hedge fund managers, which are high in demand, and who have done well, recently. Therefore, there appears to be a bifurcation of investor expectations on fees.
In 2018, we saw hedge fund managers look to exploit specific investment ideas outside the main fund by offering these to strategic investors. These took different forms, depending on the investment idea, the specific assets, the investor and the way in which these opportunities were housed. Separate “co-investment” vehicles were popular, as they often afforded managers more flexibility when it came to negotiating issues such as liquidity, fees, reporting and expenses. 2019 is likely to remain a difficult capital-raising environment for managers, so co-investments may continue to provide a way to attract additional assets by monetising existing investor relationships.
Additionally, we also expect to see some further cross-over between investment disciplines in 2019.
Hedge Funds have shown an increasing appetite for early stage investment in the past few years, occupying the space of traditional venture capital investors. This is a trend that may well continue into 2019 and beyond, especially in the case of specific sectors such as pharma, biotech and digital technology, where specialist managers have sufficient research and analysis capacity of their own to take advantage of these opportunities. In many ways, this movement is seen (along with technology and the rise of crowdfunding type forums) as a democratic disruption of the investment process for venture capital, in much the same way as the institutionalisation of hedge funds over the last two decades has had a similar effect in a space once the purvey only of high net worth and boutique investors.
Convergence between hedge funds and private equity is certainly not new, although 2018 highlighted yet again that there is a significant (and potentially growing) overlap in the investor base between the two disciplines. With many institutional investors perceiving hedge funds to be expensive relative to recent performance, any increase in redemptions may mean that there are more funds available to be deployed to comparatively more attractive, longer-term opportunities.
As such, we expect to see investment in hedge fund strategies continue, albeit on a more selective and perhaps slower basis in 2019, while seeing some hedge fund investors continue to review their private equity exposure, continuing the trend of recent years.
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