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It is no secret on Wall Street that hedge fund returns haven’t been a source of excitement this year. In fact, hedge funds have struggled to post gains of only 4.6 percent to date, despite the S&P 500’s meteoric climb past 15 percent in the same span of time. While many would expect hedge fund managers to be concerned about their performance, Kevin Roose of New York Magazine reported that the atmosphere at the fifth annual SALT hedge fund conference remains upbeat. That’s because, even with the considerable under-performance to date and over the past few years, the hedge fund industry continues to earn high fees as well as attract large sums of new investment capital. Why is this?

It comes down to institutional investors, particularly pension funds, that aim for regular, consistent absolute returns every year, something equities cannot provide alone due to market volatility. In the past, these investors could diversify their portfolio using bonds, but the current interest rate environment isn’t providing sufficient levels of returns in order for the funds to meet their hurdle rates. So pension fund managers are looking for alternative asset classes that have characteristics similar to bonds, but offer higher returns. Some private equity strategies offer these types of returns, but more commonly, hedge funds are viewed as the answer. Hedge funds that employ market neutral strategies in particular that offer consistent, albeit lower, returns over time have seen a lot of attention from struggling pension portfolio managers.

In exchange for offering more management intensive strategies, hedge funds generally charge fees substantially higher than what one would see in an actively managed equity fund. Typically, this is done as a 2 percent fee upfront for assets under management and 20 percent cut of any profits the fund earns. While some would anticipate fees would come under pressure due to the low levels of returns, the industry isn’t really seeing any decline in their revenues.

“I keep waiting for fees to go down, but they’re only going up,” Jan Buchan, a hedge fund industry veteran, told Roose at the conference.

This view is consistent with the results observed amongst leading funds. For example, John Paulson, who has lost $9.4 billion over the past two years for his clients, is still charging his regular fees. In fact, he’s still attracting investors. As an overall industry, hedge funds took in $817 million in new investor capital in April 2013 alone. There certainly isn’t a great deal of pressure on this group of fund managers, despite less than stellar returns.

What are the Implications for Hedge Fund Job Seekers?

As a result of stable fees, hedge funds have been able to offer more stable opportunities than their financial industry peers in investment banking or asset management. While there has been some pressure on the regulatory front that has increased expenses, along with jurisdictional questions for some funds, hedge fund employees have largely been able to rely on their employment more than their peers. This should continue into the foreseeable future, as long as interest rates remain low and hedge funds are positioned as one of the most attractive alternatives to the fixed income asset class.

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After a strong finish to 2012 that saw many hedge fund managers enjoy the largest profits in several years, many in the industry are now becoming hopeful that 2013 will bring the same level of success. The Financial Times is reporting that the first quarter of this year will likely be one of the strongest ever for many hedge funds, as they ignore global economic concerns and pile into riskier assets.

In what may be a surprise to many, European-focused equity funds have been some of the strongest performers to date. For example, the largest European equity fund manager, Landsowne Partners, saw its flagship fund climb 7.75 percent in the first two months of 2013. Whether European funds can maintain their edge amidst gathering economic storm clouds remains to be seen, though many funds have built a significant buffer of positive returns already this year. Other top performing European managers, according to the Financial Times’ report, included Sloane Robinson, with a 17 percent year to date return, and Egerton, who enjoyed an 8 percent climb in the first two months of the year.

These returns also compare well to global equity benchmarks, which is a positive development for an asset class that has struggled to outperform equity indices for some time. While an 8.5 percent rise in the S&P 500 is certainly strong overall performance, top performers in the hedge fund industry are now providing even stronger returns to their investors. Over the past five years, the average hedge fund has only returned 8 percent to investors, so to see that kind of performance in a matter of two months is encouraging.

Are Returns Symptomatic of Excessive Risk Taking?

One concern for investors will be whether the increase in returns is simply reflective of hedge funds taking on risk in a desperate attempt to maintain their assets under management. There is no doubt that significant macroeconomic risks are beginning to cloud the outlook in Europe, threatening in some cases the very existence of the Eurozone. On the other hand, many experts believe that the worst is over, and with established frameworks now in place for dealing with most perceived financial risks, little downside remains. In fact, many hedge fund managers are pointing to a higher risk tolerance in 2013 being responsible for some of the sustained gains.

Luke Ellis, President of the Man Group, told the Financial Times, “Last year and in 2011, everybody jumped at every shadow. This year, if you look at the shadows – the Italian Election, sequestration in Cyprus, things that would have caused a massive run for the doors – we have been able to ignore them.”

That said, the potential for a black swan event stretching financial stability mechanisms to the extreme still remains, and many would argue that Europe is certainly not out of the woods yet. The concentration of European funds among the strongest performers in the first months of the year does point to a reliance on further positive economic and political developments from the Eurozone. If that materializes, hedge fund returns could certainly remain elevated for 2013.

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Hedge Fund Size a Key Driver of Performance

March 11, 2013

The performance of hedge funds based on relative size has been a topic of discussion for several years. Many studies have been published attempting to determine whether fund size is a key indicator of expected returns. In order to add additional information into this debate, recently took a look at the results of 3,000 […]

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Hedge Fund Industry Posts Positive Growth in 2013

February 25, 2013

The hedge fund industry saw its assets under management climb to $2.6 trillion in 2012 as strong performance and net investment inflows benefited the sector. Performance alone accounted for $116.3 billion in growth as stronger global markets created more opportunities for hedge fund managers. In terms of investor flows, the sector saw $29 billion in new […]

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Hedge Fund Performance Forces Cuts

October 22, 2012

Hedge funds across the world are cutting trading desk resources as pressures on the financial industry continue. In a recent Greenwich Associates survey reported by Bloomberg, 44 percent of hedge funds indicated that they will reduce their spending on trading activities this year in comparison to 2011. This is largely the result of increasing pressure […]

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Hedge Fund Returns Declining, Risk Taking Up

October 15, 2012

The first three quarters of 2012 have been rather weak for the hedge fund industry, posting returns of 3.04 percent, when compared to the relative strength of the S&P 500 index, which returned 13.97 percent over the same period. Mary Ann Bartels, an analyst with Bank of America Merrill Lynch, told the Financial Post that […]

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Hedge Fund Industry Posts Strong Performance in August

October 11, 2012

The hedge fund industry has posted strong gains in August, according to a Reuters report, lifted by rising global equity markets. The SS&C GlobeOp Hedge Fund Performance Index rose 83 basis points in August and has posted a 6.76 percent return over the first eight months of 2012. This index tracks the hedge funds administered […]

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