Hedge Funds Face ‘Make or Break’ Year, Warns Insurance Investor

By Laurence Fletcher | April 18, 2012

Large institutional investors who have ploughed tens of billions of dollars into hedge funds may rethink their allocations if the industry performs poorly yet again this year, one large U.S.-based investor said.

Christopher Vogt, global head of hedge funds at Allstate Investments, which has $95.6 billion assets including around $1.5 billion in hedge funds, said the industry needed to deliver good returns in 2012 after several difficult years.

“This is a make-or-break year for hedge funds,” he told Reuters in a recent interview.

“If they have another low-to-zero return year then you will have had a three-year cycle of very low absolute returns.”

His comments come after a disappointing 2011 for the $2 trillion industry, once viewed by many investors as being able to make money in all market conditions.

The average hedge fund fell 5.2 percent, according to Hedge Fund Research’s HFRI index, while the S&P rose 2.09 percent, as funds struggled amidst market volatility caused by the euro zone’s deepening debt crisis.

Equity hedge funds, one of the most popular sectors, were down 8.4 percent after correlations between stocks soared. This hurt funds’ so-called pairs trades – a bet on one stock rising and another stock in the same sector falling – as shares rose and fell in unison.

The losses made 2011 the second negative year in four – funds fell 19 percent in 2008 during the worst of the credit crisis as markets tumbled and prime brokers cut back borrowing. In 2010 the average fund gained 10.3 percent, although this lagged the S&P’s rise.

Hedge funds have gained 4.9 percent in the first three months of this year as the European Central Bank’s 1 trillion euro ($1.3 trillion) cash injection to try and avert another credit crunch lifted most asset classes.

This is less than the S&P’s 12.6 percent total return, as many funds were positioned defensively and therefore missed out on the start of the rally.

“So far, returns out of the gate this year are pretty good. You’ll need a full year of flat-to-down returns before pension funds start to rethink their allocations to hedge funds,” said Vogt.

Institutional investors such as pension funds and endowments have been the backbone of hedge fund client lists since the credit crisis, when many wealthy individuals – once the major investors in the sector – sold out.

Data from HFRX shows funds have lost 0.42 percent so far this month, as markets have fallen on fears the euro zone’s debt crisis will worsen.

Vogt also criticized the industry for being too correlated to other asset classes and for losing some of its so-called ‘alpha’ – profits due to a manager’s skill rather than market moves.

“Alpha has been declining, correlations to traditional risk premia have been higher and there have been low levels of absolute return,” he said.

“It’s a toxic trio that sends a lot of pension funds and other investors back to the drawing board to reconsider their allocations.”

Allstate Investments is the investment management subsidiary of insurer Allstate Corp.

($1 = 0.7656 euros)

(Reporting by Laurence Fletcher; Editing by Mark Potter)

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