Hedge Fund First Quarter Gains Are in the Black

Hedge funds posted an aggregate 2.3 percent gain through the first quarter, which marks the strongest start for the industry since 2013. Long/short equity strategies lead the pack with composite returns of 3.2 percent.

Back to Reality

At first blush, this sounds terrific but, realistically, the industry is beating a very low bar—its own performance record. The unvarnished truth is that hedge fund performance continues to compare poorly to the S&P 500 Index, which returned 6.1 percent in the same period, almost three times hedge funds’ aggregate gains. Even the wildly successful long/short strategies posted gains that represent only about one-half the S&P 500 gains.

According to Prequin, the quarter breaks down as follows: January saw gains of 1.46 percent, followed by February gains of 1.01 percent and ending with March gains of 0.68 percent, which totals 3.15 percent, a more generous result than the 2.3 percent reported by eVestment. Regardless of the disparity, one thing is clear, the direction is wrong with gains diminishing each month during the first quarter.

Cause for Concern?

Actively managed funds of all stripes are under pressure. Blackrock’s actively managed equity portfolio lost $42 billion between 2013 and 2016. More broadly, actively managed equities lost $442 billion in the past twelve months as $542 billion flowed into passively managed index funds, representing a nearly trillion-dollar shift.

Hedge funds have seemingly countered by adopting an “if you can’t beat ‘em, join ‘em” strategy. Hedge fund investment in ETFs have surged 77 percent, rising to $43.7 billion while the actual number of hedge funds investing in ETFs have risen by 17 percent, this according to Deutsche Bank’s 2016 Guide to Institutional ETF Ownership.

One can’t help but be concerned about the motives behind hedge fund investment in what is arguably a rival investment vehicle—an investment vehicle that has attracted $1.44 trillion from about 3,500 institutional investors, representing 59 percent of EFT assets.

What Is the Answer?

Hedge funds do not invest in EFTs as a core asset building block. Rather, such investment provides quick, efficient asset class access and to provide liquidity. This liquidity can then be leveraged to provide the fund with the ability to execute large trades without significant market impact. In short, hedge funds use ETFs as completion strategies, as tangible satellite positions, for cash management, for liquidity access, and risk management.

In the hedge fund industry tradition of innovation, hedge funds are using ETFs to their greatest advantage.

What is the Relevance to Hedge Fund Jobs?

The Deutsche Bank report offers palpable evidence that hedge fund investment in EFTs is on the rise. It follows that individuals with a background in ETFs may have just the credentials required by hedge funds exploiting ETFs for the purposes outlined above.

More to the point, it is instructive to learn that the spirit of innovation is an important attribute for anyone that seeks a position in the hedge fund industry. How “outside the box” is a strategy that sees hedge funds investing in a competitor?

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