Hedge funds sitting on record amount of capital

Roaring stock markets and rising concerns over the Federal Reserve's five-year quantitative-easing program is playing right into the hands of the hedge fund industry, which now sits on a record $2.4 trillion. “It's not at all surprising that as the markets move to new highs, more investors are realizing it's time to diversify beyond long-only,” said Jon Sundt, president and chief executive of Altegris Investments Inc. “Right now, investors are faced with equities at all-time highs and growing fears of rising interest rates, and they're looking for places where they can find some value and diversification.” According to a report out today from Hedge Fund Research Inc., the second quarter marked the fourth consecutive quarter of record asset levels for the hedge fund industry, with assets jumping $40 billion jump during the three-month period. The total asset growth includes both appreciation and net inflows, which totaled $14.5 billion during the quarter. That compares with $15.2 billion of net inflows during the first quarter and $34.5 billion in net inflows for all of last year. “Even though most of the first half of the year has seen relatively low volatility, I think investors are starting to understand the macro and noncorrelated benefits of some of alternative strategies,” HFR president Kenneth Heinz said. “Investors are realizing that the opportunity set is broader than just investing in large-cap equity,” he said. “In order to participate in these markets today, you really need to be invested both long and short.” The increased appetite for alternative strategies also is showing in mutual fund asset flows. The alternative fund category, as tracked by Morningstar Inc., had $11.1 billion in net inflows during the second quarter, following net inflows of $9.2 billion during the first quarter. In the case of the mutual funds, the assets flowed in despite flat performance, including an average decline of 0.8% during the second quarter and an average gain of 0.8% during the first quarter. It has been a similar performance story across much of the hedge fund universe. The HFRI Fund Weighted Composite Index generated its entire 3.6% gain this year in the first quarter, followed by a flat second quarter. By comparison, the S&P 500 gained 2.9% in the second quarter after a 10.6% first-quarter gain, for a six-month gain of 13.8%. On the fixed-income side, the Barclays Capital Government/Credit Bond Index has suffered two negative quarters for a six-month decline of 2.8%. “Right now, there is a lot of money that had been sitting in bonds and is looking for a new home, and you've also got money getting pulled out of emerging markets,” said Sol Waksman, president of BarclayHedge Ltd. “Keep in mind that the commodity markets are down, and a lot of people are feeling that with the slowdown in China and the strengthening U.S. dollar, it's time to look at the U.S. economy through hedge funds.” BarclayHedge hasn't yet reported its June hedge fund industry data, but Mr. Waksman described May as “one of the strongest months for net inflows in more than two years.” Although the direction of flows and overall asset growth has demonstrated a strong rebound over the past few years, this is an industry that took some big hits at the start of the financial crisis. In 2008, the hedge fund industry had $154 billion in net outflows and shrunk to $1.4 trillion. The HFRI Index lost 19% in 2008, which compared with a 37% drop by the S&P 500. The outflows in 2008 were followed by $132 billion in net outflows in 2009, even though the industry's total assets grew to $1.6 trillion as the HFRI Index gained 20%. The S&P 500 gained 26.4% in 2009. Prior to the financial crisis, the last time the hedge fund industry finished a year with net outflows was 1994, following the infamous collapse of the Long-Term Capital Management hedge fund. Total assets in the industry in 1994 were at $167 billion. It saw net outflows of $1.1 billion. “I think the recent flows have occurred in an environment where there is still a good degree of uncertainty about new regulations,” Mr. Heinz said. “The asset flows are encouraging at a time when regulation in the U.S. and Europe is seen as an obstacle, and the performance hasn't been as exciting as the S&P.”