Hedge Funds’ Competitive Edge in a Tough Environment

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By Roger Woolman Investor Services Industry Expert
February 14th 2023 | 4 minute read

Hedge funds, observed Preqin’s Alternatives in 2023 report, experienced a tough 2022.

The Preqin All Strategies Hedge Fund Benchmark fell -6.75% over the course of the year. That was its biggest drop since 2008, when returns tumbled -13%. Through 2022, hedge funds are reported to have lost over $200 billion of client cash.

“Market participants experienced major pullbacks in their portfolios and investors struggled to find a safe way to protect their capital,” Preqin research analyst Sam Monfared noted in the report. “Inflation figures spiked globally, and the Russian invasion of Ukraine and geopolitical tensions added to the volatility. The simultaneous declines in public equities and bonds created an environment that many investors were not anticipating.”

Relative performance

Overall industry performance was better than the -17.7% gross returns achieved by the MSCI World Index, with many hedge fund managers providing protection, and even some gains, against a challenging backdrop. Still, that is what paying hedge fund fees is supposed to deliver.

The headline figure masked some wide performance divergence though. Macro and relative value strategies were among the best performers, achieving positive numbers for the year. Event-driven and equity strategies were among the worst. Medium (-2.35%) and small managers (-4.41%) generally outperformed large ones (-4.86%), as they have done on a three-year annualised basis.

Going forward, investors will “continue to gain from the industry’s ability to produce attractive risk-adjusted numbers,” stated Preqin’s Monfared, with volatility and monetary and fiscal policy adjustments creating pockets of inefficiencies managers can exploit. That said, hedge fund investors “are known to add and remove capital to the asset class based on the momentum in the market.”

Last year this reactivity translated into net outflows to the tune of over $55 billion, according to Hedge Fund Research (HFR) figures. Add in the negative returns and HFR calculated total global hedge fund capital finished the year at $3.83 trillion.

How hedge funds can attract allocations

So what can hedge fund firms do to hold on to, and hopefully increase, their client allocations from here?

Providing outperformance is obviously crucial.

“Leading funds continue to position for a fluid trading environment and accelerated cycles of volatility, with increased potential for destabilizing dislocations across all asset types,” noted HFR president Kenneth Heinz. “Once again, strategies which have demonstrated their ability to navigate the current extreme market volatility are likely to attract capital from leading global financial institutions seeking to stabilize their portfolios from losses in long equity and fixed income exposures”.

Yet performance by itself is not enough. Strength, efficiency and service matter too.

Operational due diligence under scrutiny

Over time we’ve seen investor due diligence processes become ever more stringent. And those examinations go beyond hedge funds’ investment strategies.

Investors, especially institutional ones, want assurance that the firms they partner with are well-managed, robust and have the support capabilities that come from a strong operational framework – whether those capabilities are maintained in-house or outsourced to a third-party fund administrator.

They want to know that net asset values (NAVs) will be accurate and generated promptly.

That subscription, redemption, transfer and dividend processing will be fast and seamless.

That fee calculations are correct and transparent.

That reports can be customised to investors’ requirements, are timely and error free.

That strong compliance controls are in place to ensure the hedge fund can meet all its regulatory responsibilities.

That the IT infrastructure has the necessary cybersecurity and disaster recovery provisions. And that systems are seamlessly integrated, to allow the smooth, hands-off, real-time flow of data across the platform.

Advanced investor servicing and regulatory compliance technology solutions supporting expert operations teams can’t compensate for a weak investment strategy. But once the investment boxes are ticked, an institutional-quality environment can be the difference between an allocation yes or no (one of the reasons why our hedge fund administrator clients saw no falls in assets under administration and were still able to grow their businesses last year, reflecting the support they provide).

In today’s competitive fundraising landscape, such operational robustness can be the vital edge hedge funds need.

Deep Pool is the #1 investor servicing and compliance solutions supplier, providing cutting-edge software and consulting services to the world’s leading fund administrators and asset managers. Our flexible solution suite, developed by an experienced team of accountants, business analysts and software engineers, supports offshore and onshore hedge funds, partnerships, private equity vehicles, retail funds and regulated financial firms. Deep Pool is a global organisation with offices in Dublin, Ireland, the United States, the Cayman Islands and Slovakia. For more information, visit: www.deep-pool.com.

Roger Woolman
Roger has over 25 years of experience as a finance & technology exec. He co-founded Deep Pool/HWM Group in 2006 & rejoined in 2021 following his role as Director of Funds & Alternatives at SS&C Advent where he oversaw business development activities for their international fund management business.