Hedge Funds May Lose Lead to Exchange Funds in 2014

The hedge fund industry is in danger of falling behind exchange traded funds in total investments for the first time in 2014 if current trends persist. Unlike hedge funds, exchange traded funds are passively managed and track a commodity, index or a basket of assets like an index fund. A major attraction for investors in exchange traded funds is the extremely low cost of investment. While a typical hedge fund charges 2 percent of assets as management fee, the cost of investing in exchange traded funds is only about 0.1 percent.

Status Challenged

With continued underperformance in each of the last five years, hedge funds are gradually losing their status as the darlings of the investment management industry. In December 2013, while hedge funds saw a big hit to fund flow, exchange traded funds pulled in a strong $24.5 billion in net inflows. According to data published in the ETFGI’s global ETF and ETP industry insights report, assets in exchange traded funds reached a record $2.4 trillion at the end of 2013. In addition to low investment cost, exchange traded funds are more liquid than hedge funds. According to data published by hedge fund tracker HFR, global hedge fund industry assets totaled $2.5 trillion in 2013.

Citing data from BarclayHedge, S&P Dow Jones Indices director of index investment strategy Tim Edwards says, “If the current trends continue, 2014 will herald a significant milestone for the ETF and hedge fund industries, as the total amount of capital invested in the former threatens to overtake the latter.”

Asset Prices Distorted

Karlheinz Muhr, who is the chairman and CEO of hedge fund QFS Asset Management says the current unconventional easy money monetary policies of central banks have distorted asset prices and made it harder for fundamentally-driven funds to thrive. Muhr adds that the current market environment is unlikely to change anytime soon and laments that funds adopting a research intensive fundamental analysis do not see enough risk adjusted opportunities.

The Greenwich-based hedge fund firm, which once managed $3.6 billion, announced this month it will close its final fund and return $1 billion in assets to its clients following losses in 2012 and 2013. QFS Asset Management was founded by well known economist Sanford “Sandy” Grossman way back in 1988.

Job Market Impact

Despite positive returns and increasing assets, hedge fund industry performance over the last few years pales in comparison to index funds and exchange traded funds. With global central banks promising to stay active in financial markets, most hedge fund managers are reluctant to make large bets and instead continue to position defensively. Such a stance will likely make the recovery in the hedge fund job market sluggish.  Only time will tell what the long term impacts will be.

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