Sometimes it’s just not all about size. Especially right now, when we’re analyzing the recent performance of hedge funds. Taking a look at what happened last year, it seems that it was these hedge funds that, according to an article in The Financial Times, enjoyed “the largest net asset growth in 2010, bucking the industry assumption that new money is flowing primarily to the biggest funds.”

"Sweet Spot" Success

Indeed, in a survey taken by Citigroup, it was shown that hedge funds between $1-5bn “experienced the largest percentage increase in assets under management,” in 2010, at a staggering figure of 37 percent. As well, in terms of that group for assets under management, there was an increase last year of $85bn, as opposed to the $30bn figure for the next level managers ($5-10bn) and $72bn for the $10bn+ group.

Maturing Industry

According to Citigroup, since the whole industry has been maturing, the exposure by pension and sovereign wealth funds to smaller funds has been expanding simultaneously. This makes a lot of sense, according to global prime finance head at the US Bank, Nick Roe who commented: “by getting in early, pensions and sovereign wealth funds are positioned to grow with the manager as they build towards the $10bn AUM point and above.” When looking at pension funds and their statistics, it becomes much clearer. Along with institutional investors, for the first three months of 2011, they had over $100bn in hedge funds, which is nearly 50 percent of the total capital that is globally invested in hedge funds, as compared to the 2002 figure of $125bn, “which represented about a fifth of the hedge fund industry.”

Alternatives Investments

These days, according to pension funds consultants Towers Watson, close to 20 percent of institutional assets “are now invested in alternatives, including private equity, property and commodities.” About 10 years ago, this figure was nearer to 5 percent. That’s a substantial increase. Why is this the case? It seems that there is a greater confidence amongst pension funds vis-à-vis making investments and thus money is being allocated “directly to single manager funds rather than funds of funds.” As well, they are now getting wise to their ability to fight for “lower charges and different fee structures.”

A recent presentation delivered by Blackrock Alternative Investors focused on the positive aspects of alternative investments along with the “diversifying role they can play in institutional client portfolios.” There were three speakers: Matthew Botein (MD and company head); Marcus Sperber (head of the company’s international real estate business) and Ken Kroner (Global Market Strategies Group [GMSG] head). Talks focused on the market challenges investors face today and how these can be encountered through alternatives. Since pension funds now have fewer options than they did some years ago due to decreasing bond yields and increasing asset prices, alternatives now have a potentially larger role. Of course, market fluxes and increasing inflation are going to provide additional challenges too. As Botein noted, institutional investors are now seeking better returns as well as “downside protection against rising prices.” In the UK especially, those with pensions are looking for ways to “de-risk.” As well, there is a greater understanding of bond and equity risks so again, alternatives are looking increasingly attractive, especially vis-à-vis inflation. This is because alternatives have the capacity to deal with these types of challenges and thus they are heading towards increased success. There is a predicted 59 percent aggregate growth this year, which is substantially higher than the figure for just two years ago. As Botein pointed out, “if we take a portfolio of equities and bonds and add in real estate, commodities, hedge funds, the portfolio, whilst enhancing returns, begins to exhibit lower volatility and correlation.”

Investors Vis-à-vis Real Estate

On the matter of real estate and investors, according to Sperber, during good times (as in, pre-global crisis) investors were raking it in at close to 20 percent per year) but there was the possible obstacle of them not quite understanding the risks associated with “opportunistic strategies.” Thus, Sperber’s advice to investors is to make “sensible” allocations while forming an understanding of “exactly what it is their investment managers are doing.” Today’s investment market focuses ways more on “core assets,” with this style now sitting at around 65 percent as opposed to the 10 percent figure in 2008.

Hedge Fund Strategy Discussion

At the end of the presentation Ken Kroner spoke about “global macro as a suitable hedge fund strategy for institutionals given that it has evolved over the last 15 years to meet their demands.” The strategy has clearly proven effective since in the last two decades it has “delivered 4-times the risk/return rate versus equities.” With these according to Kroner, “and investors have a clear understanding of the driver behind investment decisions.” Since global macro managers are able to invest in anything due to unstable global markets, this is also advantageous. It is very attractive to investors that all investment views “can be expressed.” Kroner concluded by saying, “global macro is one of the most liquid strategies in the hedge fund space and able to deliver diversified returns. It’s no longer a case of ‘have a hunch, buy a bunch, go to lunch’. Sound economic decisions, liquidity and a clear evolution enable global macro to meet the needs of today’s institutional investors.”

Hedge Funds Helping Banks

Just because on one side of the coin things can look disastrous, does not mean that this will be the case for the other side of the coin. In fact, just by looking at various big name banks, one can see how the financial crisis may have in some way been beneficial to them. At the time hedge funds had to cut ties with various investment funds, banks like Credit Suisse, Citigroup, Deutsche Bank and UBS came out smelling like roses. Citigroup for example, “picked up several hedge fund clients it would previously have struggled to lure away from the big three prime brokers [Goldman Sachs, Morgan Stanley and Bear Stearns].” While this was definitely good news for Citigroup, it is hoped that the mega bank didn’t pop open the champagne straight away since the excitement was extremely temporary.

Citigroup Still Succeeds

But being the mogul that it is, Citigroup still did pretty well. According to the company’s global head of prime services, Nick Roe, it has been successful in “attracting a more sustainable flow of new funds.” Indeed, Roe pointed out that, “post-crisis, as Citi stabilized, a flood of new business came through the doors and we built up a great deal of momentum. We have an aggressive budget for 2011 and indeed we are already ahead of this.” Following this, the bank has been “hiring aggressively in prime brokerage,” attempting to really make the most of its strong “global transaction services arm,” with which Citi has a “symbiotic relationship.” Citi has been putting a lot of its focus on the “alpha space,” establishing platforms to facilitate investment strategy access for institutional investors in an attempt to “generate excess returns.” One alpha Citi set up was three years ago for ATP, a Danish pension fund. Roe believes that a substantial proportion of Citigroup’s work has “made the business more efficient and nimble and more client- centric than in previous years.”

Hedge funds increased 1.86 percent last month and industry assets hit their own record of $2.02 trillion. Indeed, the Paulson Gold fund had what to celebrate last month, going up 8.4 percent. But it was good news all around for the hedge fund industry last month, especially with the peak in prices for energy and precious metal. Still, the general market was experiencing some not-so-great news.

More Monies

The extra monies have mainly come from high net-worth individuals, endowments and pension funds. Indeed, combined, these monies have reached the $32bn figure which have gone into the hedge funds during the first quarter of 2011. This has rendered the hedge fund industry assets to a total of $2.02 trillion, the “biggest since the third quarter of 2007.”

In addition, other April figures showed a 1.86 percent increase in the HFR index (reaching 3.5 percent), with a jump of 2.9 percent for the Standard & Poor’s 500 index in April, leading to a total gain of 8.4 percent for the whole year.

Mega Macro Maximization

And the world macro funds had reasons to turn their lips upwards too. It has become accustomed to making large “bets on energy, metals, currencies and interest rates posted some of the month’s biggest gains, rising 4.81 percent.” Data for the beginning of the year showed an increase of 3.39 percent for such funds but March, a loss of 1.71 percent.

Performance Prediction?

Okay so this all looks really great. But is this trend set to stay? Apparently there is some concern over what is about to happen this month, most certainly with “global macro funds given this week’s tumble in commodities prices.” Last Thursday’s oil prices dropped 8.6 percent – its nadir since the middle of March. According to co-founder of the Hennessee Group Charles Gradante, “gold, silver and oil were strong performers in April. While silver and gold experienced a correction over the last few days, most managers believe silver and gold will continue to increase until there is evidence of a rise in interest rates, which would strengthen the dollar.”

Other Results

It’s not just been good news however. In fact there have been bad results, and mixed ones too. For examples, the hedge funds which bet on stocks falling had a drop of 3.15 percent on their return and Paulson & Co (a fund worth $36 billion) was up 8.4 percent last month (going up 7.8 percent for the whole year). Yet fund of fund firms that try to choose hedge funds for their investors acquiesced almost $4.8 billion, rendering “the largest quarterly inflow since the second quarter of 2008.”

At the end of the day, even looking at recent figures, it’s pretty tough to try to work out what the future holds for the industry. So the hedge funds just need to enjoy their good fortune when it happens and hope the trend stays.

Doug Rothschild, managing director at Agecroft Partners said “Over the next ten years we will see a significant increase in the percentage of their hedge fund portfolio away from the largest managers to small and mid-sized managers.”

Rothschild and his company feel the change will occur as a result of the “nimble”-ness of smaller hedge fund managers. Another reason may be because smaller hedge funds have been bringing in more income. According to Hedge Fund Research, hedge funds that manage less than $50 million return around 13.1%, while $1 billion-plus funds return 11.62%.

It is certainly not surprising that pensions such as the New Jersey Division of Investment and the California Public Employees’ Retirement System are keeping an eye on smaller hedge funds. Agecroft Partners predicts that pensions will continue to shift in this direction.

Today over 6% of all pension fund assets are of the Taft-Hartley variety, representing 420 billion dollars worth of investment capital. Since this is certainly a significant amount of money, it is worthwhile to learn a bit about what these funds are.

Taft-Hartley pension funds are the way companies provide benefits to their employees at retirement. The funds are composed of contributions which the employer makes on behalf of their employees, contractually negotiated by the union that the worker is a member of; and the gains or losses that the fund is subject to while it is invested by the fund’s trustees.

Trustees are appointed in equal number by both the union and the employer, and are responsible for overseeing the investment and deciding what benefits the plan can afford upon retirement.

Usually investment firms are given the responsibility of overseeing the fund’s investment strategy as the trustee. There are many firms which oversee Taft-Hartley pension funds, including EnTrust Capital Inc.; McMorgan & Company, John F. Santaguida managing director, and consulting firms, such as Milliman, which advise trustees on how to focus on targeting the investment returns assumed by the plan.