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Those in the industry have come to appreciate the volatility in hedge fund investment, particularly the “moodiness” of investors. One month hedge funds are the answer to low fixed income yields, the next month they are an alternative investment class with potentially harmful tax consequences. While the core investors in hedge funds have remained committed, some investors do tend to run hot and cold with their hedge fund portfolio.

According to Reuters, in November the SS&C GlobeOp forward redemption indicator, which measures clients providing notice of withdrawal as a percentage of total asset, climbed to 5.19 percent, up from 3.19 in October. This marks the highest level of hedge fund redemptions since December 2009. About 10 percent of all hedge funds are administered by SS&C GlobeOp and form the basis of their data.

Potential Changes in U.S. Taxes Strike Fear in Investors

One of the current drivers of redemptions in the hedge fund industry is the ongoing concerns around tax issues. Uncertainty around U.S. tax policy moving forward following President Obama’s re-election has markets skittish. Mr. Obama has been vocal in his desire to tax wealthy individuals more aggressively, and many that have their personal assets tied up in U.S. based hedge funds may be considering a move offshore or to more tax efficient asset classes. Whether such tax changes materialize is unknown at this time, but once announced, it may be more difficult to make moves to avoid or minimize taxes, especially if some components are retroactive.

Fiscal Cliff cause a fall in Hedge Funds as well

In addition to the tax concerns, investors are seeing the upcoming fiscal cliff as a potential problem for hedge funds from a variety of angles. With a split Congress and leadership on both sides of the aisle that has not been willing to negotiate in the past, a permanent solution seems like a longshot, though there may be an intermediate resolution to push the issue out for several months. Nonetheless, the uncertainty is weighing heavily on all financial markets and hedge funds are not exempt. Most economists believe that if no agreement is reached by or soon after January 1st, the U.S. and global economies will suffer a significant setback. Broadly, hedge funds are not immune from macro changes in the global outlook, and returns will likely suffer at least to some extent in the event an agreement cannot be reached.

With that considered, market neutral or relative value strategies, for example, may actually outperform traditional asset classes in such an environment. That doesn’t necessarily mean that investors, especially institutional investors with squeamish plan members, will appreciate these nuances and hold through the cycle. Often pension plans and other institutional investors with fiduciary duties tend to stray from alternative asset classes during turbulent market conditions, such as those we’re seeing today.

While the remainder of this year looks to be uncertain and full of risk for the hedge fund industry, 2013 may pose some opportunity to the upside. SS&C does suggest that there is a great deal of capital on the sidelines, and a return to more stable fiscal policy in the United States and Europe may encourage additional risk taking. This bodes well for the hedge funds specifically and the financial industry as a whole.

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