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Hedge Funds

US hedge funds are looking to take advantage of new stringent capital rules on European banks to buy discounted asset-backed securities and bad loans from European banks. Bloomberg reports that hedge funds are competing with private equities for discounted assets in Europe and are hiring staff as well as relocating executives in hopes of finding sellers of distressed assets at throw away prices. A report by UK’s Royal Bank of Scotland Group Plc shows that European lenders have sold distressed assets worth 3.5 trillion euros since 2012. The report adds that Eurozone banks need to sell a further 1.8 trillion euros by 2018 to comply with regulations on capital and leverage.

US Funds Shopping in Europe

Bloomberg reports that Ellington Management Group LLC is among funds active in the European asset-backed securities market. The $5.6 billion Old Greenwich, Connecticut-based hedge fund opened an office in London two months ago and has hired Daniel Turner from Chenavari Credit Partners LLP to head its asset-backed securities business. The fund is targeting to add three more people to work on opportunities in Europe. Laurence Penn, a vice chairman of Ellington says the fund’s move into Europe is a result of the pick up in the volume of asset sales from European banks.

Other hedge funds that made similar moves include the New York-based funds MKP Capital Management LLC and GoldenTree Asset Management LP.  MKP Capital sent key executive Christopher Muller to the UK to get a firsthand assessment of the opportunities. It also pouched Pritesh Solanki from HSBC Holdings Plc to lead its operations. Nilam Patel, who is a partner and money manager at the firm, says asset-backed securities in Europe offer attractive investment opportunities due to greater risk premium and improving fundamentals.

Hedge fund GoldenTree Asset Management LP, on its part, relocated fund manager Cee Sarabi from New York. Another New York hedge fund, Marathon Asset Management LP, which has roughly $11 billion under management, operates a fund focused solely on distressed assets in Europe.

Bargains for as Low as 5 Cents on the Euro

Working against a deadline issued by the European Central Bank to strengthen balance sheets by November 2014, the Eurozone lenders are disposing of bad loans at deeply discounted prices, ranging from five cents to 40 cents on the euro, according to consulting firm PricewaterhouseCoopers LLP. One such transaction was the sale by Spanish bank Banco de Sabadell SA. The bank revealed in December that it sold 632 million euros of distressed debt for a paltry 41.2 million euros representing just seven percent of face value.

The move by US hedge funds to look at opportunities across Europe is a typical example of the way hedge funds operate. When the funds see opportunities, they move in quickly and aggressively.  Such a focus on generating returns and the flexible approach of hedge funds to investing in different asset classes are factors that attract top talent to the hedge fund industry.

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Investor redemptions at hedge funds hit the highest level in December in more than four years according to the SS&C GlobeOp Capital Movement Index which tracks the monthly hedge fund subscriptions and redemptions. For December, the index showed a negative reading of 3.56 percent, the biggest negative reading since September 2009. While high end of year redemption is nothing new, the continued underperformance of actively managed hedge funds versus the index funds may have resulted in bigger outflow last month. In the year ago period, the same index showed a negative reading of 2.61 percent in December.

Another Lackluster Year

Hedge funds underperformed the Standard & Poor’s 500 Index for the fifth straight year in 2013. Hedge fund performance, as tracked by the Bloomberg Hedge Funds Aggregate Index which tracks roughly 2,300 funds, came in with a gain of 7.4 percent for the year. In comparison, the S&P 500 climbed a stunning 32 percent in 2013 for its best performance since 1997. In a Goldman Sachs survey conducted at the start of the year, hedge fund investors had indicated expected returns of 9.2 percent in 2013.

Jay Rogers, president Alpha Strategies Investment Consulting Inc., which advises hedge fund clients and managers, was not surprised by the underwhelming performance. He attributes the weak hedge fund performance to losses in short positions which many funds take to hedge positions.

Some Funds Outperform

Despite overall poor performance, there were some impressive winners during the year. UK’s The Children’s Investment Fund Management which has roughly $8 billion under management gained a stellar 47 percent on strong performance of its portfolio companies Airbus Group, Japan Tobacco Inc, and French engine producer Safran SA. Boston-based hedge fund Whale Rock Capital Management LLC did even better – gaining 53 percent during the year. Its bets include movie rental firm Netflix which tripled during the year. Whale Rock has $675 million under management with 40 percent of its portfolio on investments outside the US.

Other big winners include activist fund Glenview Capital Management LLC with a 43 percent return and Trian Fund Management LP with a gain of 40 percent. New York-based hedge fund Solus Alternative Asset Management manages $3.6 billion and specializes in distressed assets. It gained 32 percent last year. The $1.5 billion hedge fund Contour Asset Management LLC was another beneficiary of the strong outperformance by Netflix. Contour made its largest bet during the year in Netflix which helped the fund gain 40 percent.

An interesting winner during the year was the $2 billion Miami-based hedge fund Everest Capital, which specializes in emerging markets investments with a particular focus on China and Brazil. The fund shifted its focus early in the year towards stocks in the US and Japan, which resulted in the fund gaining 41 percent in the year.

Widely followed activist investor Daniel Loeb reported 25 percent return for his firm Third Point LLC, and another closely followed hedge fund manager Bill Ackman managed to generate 9.3 percent gain for his largest fund Pershing Square International Ltd., despite a big loss on his short position in multi-level marketing company Herbalife Ltd.

Job Market May Remain Subdued

Aggressive hiring is unlikely in an environment of continued underperformance by a vast majority of hedge funds over a prolonged period. Investor frustration over underperformance may also grow and could lead to greater outflows and smaller commitments. With many hedge funds struggling to deliver anticipated investor returns, cost will continue to be a factor and hiring will most likely be selective at best.

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Hedge Funds May Lose Lead to Exchange Funds in 2014

January 27, 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 […]

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European Hedge Funds Struggle to Enter US Market

June 24, 2013

Over the past several years, large U.S. institutions have become an increasingly large portion of hedge fund inflows. In fact, according to a recent Reuter’s article, pension funds, endowments and other large scale American money managers now account for up to three quarters of new money flows into the hedge fund sector. Accordingly, the importance […]

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Hedge Funds Faced with Tax Uncertainty in UK

June 10, 2013

In most jurisdictions around the world, and particularly in Europe, governments and regulators are examining a number of options to rein in compensation for financial industry professionals. In the UK, the government there imposed substantial taxes on high income earners, and, not surprisingly, hedge funds have worked to develop structures in order to pay their […]

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HSBC to Double Hedge Fund Prime Brokerage in Asia

June 3, 2013

Along with economic growth and climbing individual wealth comes increasing demand for alternative asset classes. And increasingly, financial institutions are looking to Asia in order to expand their hedge fund businesses in line with this opportunity. HSBC is the most recent institution to look at one of its traditional markets and consider expansion of their […]

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Macro Funds Sense Opportunity to Outperform

May 27, 2013

Despite being the laggards of the hedge fund industry over the past five years, macro funds are looking to return to form in 2013 as a dramatically shifting global environment plays to their advantage. However, some trends observed by industry experts may weigh on the ability of managers using these strategies to outperform the broader […]

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