Fitch Says Institutions Continue Pursuit Of Absolute Returns

Apr 1 2011 | 9:12am ET

Institutional investors increased their allocations to hedge funds and other absolute return strategies in 2010 and will continue to do so in 2011, says Fitch Ratings in its latest sector update. This will be partly due to regulations that push institutions to “take active risk while satisfying regulatory de-risking of their balance sheet.”

Fitch finds that most hedge funds and absolute return strategies “served their purpose” in 2010, on a risk-adjusted performance basis. Not so “Newcits” funds, however. The performance of these regulated funds managed by HF managers was “disappointing” according to the ratings agency, and has raised questions about “the validity of this new market segment.”

The report notes that global macroeconomic imbalances combined with trend reversals provided opportunities to relative value-oriented strategies in 2010 while rising risk appetite and the short-lived appearance of clearer macro trends in Q4 favored alternative directional strategies until another sharp trend reversal in late February 2011.

Some of the more successful long beta calls in 2010 (narrowing credit spreads, rising equities, rising emerging markets) are being reassessed, says Fitch, given “current valuations, rising geopolitical risks, potentially weaker growth, higher inflation and ongoing fiscal consolidation.”

The report also notes the new banking rules that are “transforming proprietary trading desks and market-making into third-party management activities” and in so doing “potentially increasing the contribution of the hedge fund industry to systemic risk.”

"Investors which were recently attracted to absolute return products for their downside risk protection characteristics also need to recognize that these strategies may not able to capture fully market upside," says Manuel Arrive, senior director in Fitch's fund and asset manager rating team. Fitch argues long-only traditional funds are better positioned than absolute return funds to participate in bull markets, and points to the relative success of long-only emerging markets funds compared to their hedge fund competitors.


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