It’s no understatement to say that the markets had a challenging year in 2007, with both banks and hedge funds under pressure. Nevertheless, despite a few high-profile casualties, the hedge funds generally came through pretty well – and some, such as the funds managed by Paulson & Co, produced amazing and unprecedented gains. So can we hope for – or expect – more of the same in 2008?
It certainly doesn’t look like getting any easier in 2008. There were without doubt some extremely difficult months during 2007 – notably in August and then again in November. But this year has started off with a month in January that was if anything even more treacherous, featuring highly bearish conditions and some wild intra-month swings both up and down, and especially for hedge funds trading equities in Europe and Asia.
In Europe, the EuroHedge Composite index was down by an estimated 1.25% in January – not quite as bad as last August or November but obviously not great, and with equity funds down on average by about 3%. In Asia, the AsiaHedge Composite was off a whopping 3.73%, the worst month on record. And after a great year in 2007 when they had been up an average of about 25%, emerging market equity hedge funds gave back an average of 5.87% in January.
Disguise
Moreover, the indices alone – which represent only the raw medians in a large universe of funds – disguise what was a much greater level of dispersion among the returns than is usually the case (especially in recent years, when market volatility has generally been low). In Europe, for instance, the standard deviation from the Composite jumped to about 5.5% this January, up from a more typical 2.07% in January 2007. And in Asia, the standard deviation leapt above 6% in January 2008, up from 3.36% in January 2007.
What these statistics on the dispersion of returns reveal is that, in times of wild swings like this in the markets, there are usually some big winners and losers. And January was just one of those periods when many equity funds – especially in Asia and emerging markets – gave back a big chunk of their recent gains, and with quite a few registering double-digit losses.
At the same time, however, there were some big winners who made off with double-digit gains on the month. These included big London-based macro funds such as Brevan Howard and CTAs such as BlueTrend (managed by the BlueCrest Capital group) as well as macro funds such as Clarium in the US.
January’s rout in long/short equity might well turn out to be a tipping point for many investors who are now suddenly looking with increasing urgency for strategies that can offer the promise of decent returns but also with capital protection – and a lack of correlation to equity markets. And so the wide dispersion of returns we have been seeing will in turn, I believe, probably drive a faster rotation of investment dollars this year away from certain strategy areas and into others.
And where will the investors turn to? Well, it seems to me that this is a much more fertile environment right now for short-term trading than it is for considered long-term fund management – and probably the first time in several years that this has been the case. And so the beneficiaries are likely to be only those equity strategies that genuinely hedge and are strong on the short side – or (more likely) funds in other strategy buckets such as relative value, arbitrage, macro and managed futures.
There is also one other strategy area where my colleagues and I in London see potential for continued growth – and this is in the so-called frontier equity markets of the Middle East, Africa and Eurasia. The growth of Emea (Europe, Middle East and Africa) and Mena (Middle East and North Africa) strategies looks like a long-term phenomenon, not just a short-term fad.
Many of the world’s smartest investors are now targeting Africa and the Middle East as a rich new source of opportunity. One notable example was the recent move by Och-Ziff Capital Management to set up a joint venture with Mvelaphanda, a South African black empowerment group; and an African investment firm called Palladino – creating a new pan-African investment operation called simply Africa Management.
Another less well known example is a $1 billion Mena long/short equity fund launched last autumn by EFG-Hermes – one of the biggest recent hedge fund launches in Europe. Put together in partnership with Harvard Management, the fund’s advisory committee comprises Harvard Management Company, Lord Jacob Rothschild’s RIT group, the Government of Singapore Investment Corporation, the Dubai International Financial Centre and top Saudi investment group Olayan. A group of savvier or more serious investors would be hard to imagine.
It will be interesting to see how well such funds do in future. Indeed, there seem sure to be more interesting times ahead.
