For our annual Looking Ahead feature, FINalternatives Senior Reporter Mary Campbell contacted over 30 hedge fund industry professionals to find out what they think the new year will bring.
Here, in their own words, are their thoughts about everything from the fiscal cliff and the macro environment to hedge fund fees the rise of retail investing.
CIO and CEO, Contrarian Capital
2012 was a superb year for disciplined investors in distressed situations, and we believe 2013 will present as good an opportunity set. While large corporate borrowers have refinanced out their “wall of maturities,” there remains more than $300 billion in middle-market bank debt that will mature over the next five years.
These distressed situations involving mid-market corporate credits have and will continue to offer bottom-up distressed investors many opportunities to purchase assets at very attractive prices. Several cyclical industries, including shipping, coal, construction materials power, and paper will present profitable entry points for investment based on underlying asset value.
While we remain optimistic about sustained U.S. growth and the beginnings of recovery in Europe, we continue to see many attractive European situations as banks struggle to meet Basel III requirements, and as peripheral European difficulties persist. The ability to navigate bankruptcy and other legal processes in many global jurisdictions offers a significant set of investment opportunities.
Finally, distressed corporate and sovereign opportunities in emerging markets have generated a consistent stream of excellent investments, often on a case-by-case basis rather than as a result of broad macro trends. Again, funds with teams on the ground globally and the skills to analyze discrete opportunities will enjoy a significant advantage.
Jim CelicoJim Celico
Managing Director, F-Squared Investments
Investors, still rattled by the financial crisis, will continue to seek out alternative solutions that allow them to participate in rising markets while offering aggressive downside risk management to avoid significant losses should the market collapse.
While institutional investors have sought these solutions for some time now, we see an increasing appetite for alternative strategies that offer daily liquidity and full transparency. To meet this demand, traditional hedge fund managers with well-known brand names and other investment firms will begin offering a wider variety of liquid alternative mutual funds geared primarily to the retail market.
We’re already starting to see capital flow out of traditional mutual funds and into alternative investments including quantitative and long-short equity strategies. But investors are also demanding active risk management, especially the focus on avoiding losses, in the fixed-income markets as fear of a bubble brewing in the bond market takes hold. We expect to see traditional fixed-income hedge fund managers begin responding to this demand in 2013 by offering long-short bond strategies to retail investors.
We also expect institutional investors to allocate more to alternative strategies next year as part of their overall equity and fixed-income strategies. Those allocations will be less about risk management than about meeting very lofty return expectations.
Armando D'AmicoArmando D’Amico
Managing Partner, Acanthus Advisers
The supply and demand imbalance in the fundraising market is at an all-time high and the environment will become even more competitive in 2013. Acanthus estimates the total demand for funds in Europe over a three year horizon of 2012-2014 at around €135 billion—€49 billion in the European mid-market (funds below €1 billion) and a further €87 billion in the European large cap (funds over €1 billion) space. Satisfying this demand would imply average annual European fundraising of around €45 billion—however, only c. €30 billion has been raised in 2012, a third lower than that required.
Meanwhile, LPs’ investment activity continues to be hindered by the continuing lack of deployment and distributions by their underlying investee funds. LPs observe that some GPs seem to view post-crisis adaptation as a sign of weakness, instead holding out hope for a return to “business as usual.” In fact, in an increasingly bifurcated fundraising market where funds of top-rated GPs can be heavily oversubscribed, LPs warily note lower willingness to compromise than ever before. Across the market more broadly, many GPs are viewed as taking a “head-in-the-sand” approach, overlooking the shifting environment and hoping the market will “come back.” Looking ahead into 2013, LPs will want to see tangible evidence that GPs have truly learnt lessons and appreciate the need for adaptation in the post-crisis environment.
Patrick HughesPatrick Hughes
Managing Partner, Guggenheim Partners
Our view for 2013 continues to be that the markets will remain volatile as the global economies continue the process of deleveraging.
We continue to believe that the right strategy for Guggenheim Global Trading is to maintain tight net exposures and focus on generating alpha through taking what we believe to be smart, diversified, idiosyncratic risks rather than attempting to call the direction of the overall market. We believe clients will continue to push back on paying high fees for returns that are largely beta driven.
John HummelJohn Hummel
President and CIO, AIS Group
As we look ahead to 2013 investing opportunities, the energy service sector stands out, particularly companies that can enhance oil recovery from existing fields. We see a unique opportunity to capitalize on growing interest in oil extraction globally and within the United States, particularly the exploration of tight shale formations, deep offshore sites and Arctic reserves.
We believe there are considerable growth opportunities within companies focused on oil exploration and extraction, seismic data companies, oilfield identification and engineering services. This will be particularly true of companies with advanced technology, which allow proprietary pricing of their products or services.
Unlike many energy investors and industry leaders, we question the optimistic forecasts of future increases in both domestic and international oil production in order to meet growing demand. It is a widely accepted fact that existing fields are losing approximately 4% of production each year due to natural attrition. In addition, oil exporters are experiencing growing domestic demand, leading to lower total exports. And lastly, non-conventional oil fields experience rapid decline rates within the first two years of production.
Since 2005, global production of conventional oil has stagnated at approximately 82 million barrels (according to the BP Statistical Review). Only recessionary conditions in the developed world combined with high prices have enabled developing countries to increase consumption from the shrinking export pool.
As easier to find oil fields have been discovered, oil exploration and extraction becomes more complex and requires more capital expenditure. This sophisticated technology makes innovative energy exploration possible, driving oil technology stocks' value. However, non-traditional energy exploration requires vast amounts of technology, capital, water and energy to extract oil from potential reserves.
Loren KatzovitzLoren Katzovitz
Managing Partner, Guggenheim Partners
With regard to the overall hedge fund industry, we have stated before and continue to believe that the industry will come under additional pressure to consolidate as the cost of operating a small or even mid-sized hedge fund, or fund of funds, continues to rise. Investors and regulators alike are requiring start-up management companies to invest significant up-front monies in compliance and risk management infrastructure in advance of taking client funding which we believe will further push smaller sector- focused hedge funds to continue to roll up into larger multi-strategy hedge funds and platforms. The days of launching a new hedge fund with $50 million or $100 million and then scaling assets may be behind us; certainly currently, possibly permanently.
Simon LackSimon Lack
Author, The Hedge Fund Mirage
2013 will be the year when bond investors begin to acknowledge the inevitably low future returns caused by the Fed’s multiple rounds of quantitative easing and debt monetization. Negative after-tax real returns will reach high-grade bond investors as they already have for holders of government debt. The relentless math, whereby the return on $100 in 10-year U.S. treasuries can be replicated with only $22 in the S&P 500 (assuming 4% dividend growth) and $78 in cash will render bonds more deadweight in those portfolios that reject an underweight position. The search for alternative sources of income will drive investors into stable dividend-paying equities, master limited partnerships and other income-generating sectors.
Hedge funds will continue to deliver mediocre results at great expense for those unwisely hoping an over-capitalized industry can emulate its smaller, formerly profitable and ever more distant past.
Dave LemontDave Lemont
2013 is the year of opportunity in the foreign exchange market. With the uncertainty in the U.S. stock market due to the election, fiscal cliff and other market events, we see investors looking for new ways to diversify their portfolios and new alternative investment strategies. The foreign exchange market is an untapped, viable asset class that many investors are seeing as an opportunity to broaden their focus and move toward uncorrelated investments. We believe investors should seek diversification in their portfolios, which is not always easy to achieve through traditional asset classes.
Transparency and liquidity are important trends for investors and the right investment products in the foreign exchange market will create accessibility while optimizing returns and risk management. It is an exciting time for investors and we look forward to continued growth in this market as we move into the new year.
Jeffrey I. RosenthalJeffrey I. Rosenthal
CPA, Anchin, Block & Anchin
As we begin Obama’s second term, we believe that we will see an increase in the regulation of hedge funds, including increased oversight and enforcement by the SEC and its regulatory brethren. A good example of this is the recent release by the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) directed to newly registered investment advisers to introduce the National Exam Program and explain the Presence Exams Initiative. An investment advisor is considered “newly registered” if it registered with the SEC after the Dodd-Frank Act became effective and resulted in the registration of many advisors to private funds.
The exams will be taking place over the next two years and will include an on-site review directed at the higher risk areas of an adviser’s business and operations including marketing, portfolio management, conflicts of interest (review of investment allocation, fees, expenses and related party transactions), safety of client assets and valuation (establishing policies and procedures including fair valuation of illiquid and hard to value assets).
At the conclusion of the examinations, the staff intends to issue a report to the SEC and the public, which will undoubtedly lead to additional rules and regulations. We have started receiving inquiries from clients and others how best to prepare for the inevitable.
Ronen SchwartzmanRonen Schwartzman
Founder and CEO, Ten Capital Advisors
We expect more of the same on the economic front: additional quantitative easing programs and money printing around the world. This means a low-growth environment in the U.S. while the deleveraging process continues.
With the elections behind us and recent peak in companies’ earnings we are cautious about U.S. equities and thus will focus our work on managers that have a net exposure of 20-40% and have a proven ability to make money by shorting stocks. To diversify our exposures we will be looking for opportunities with event-driven managers that have a focus on credit/special situations expertise and can invest across the capital structure. Another area of focus may be global macro strategy with managers that have exposure to interest rates, FX and commodities and a low exposure to equity.
We think Europe has turned a corner and that there are some attractive opportunities in equities and loans. That is not to say there won’t be volatility in the markets but we will be looking to increase exposure to the region.
And last, we continue to believe that emerging and smaller managers will outperform the large and more established funds.
Looking Ahead: The Hedge Fund Industry Speaks