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.
Sam DiedrichSam Diedrich
Associate Director, PAAMCO
The outlook for hedge funds in 2013 is, in my view, cautiously optimistic. Marginal contributions to the global equation for growth will likely center on the conditions in the U.S., where I think the uncertainty points mainly to the upside. Provided the fiscal cliff is resolved on a reasonable time-line with minimal long-term economic implications, I see a strong possibility for further improvements to growth in the U.S. because of the improving housing market, strong corporate balance sheets, low rates, booming credit market, and highly accommodative monetary policy. This bodes well for U.S. equity markets and most likely for credit, but Treasury holders appear ill compensated at current yields.
Upside growth potential in the U.S. is juxtaposed with Europe, where complex structural issues remain with few viable near- to medium-term solutions. Creative monetary policy has carried the day so far, but the potential for volatility spikes caused by fiscal and policy stumbles remains high. It’s simply unclear how European sovereigns can continue to cut spending and grow their way out of the debt load simultaneously.
Finally, Asia seems most likely to remain in the background, despite the prospect for some surprises. In China, upside potential exists in the form of economic reform and infrastructure stimulus. The outlook for Japan is more exciting now than in recent years and this may lead to sustained moves lower in the Yen which would improve prospects for exporters.
Ed EgilinskyEd Egilinsky
Managing Director, Alternative Investments, Direxion
Despite the strong performance of U.S. equities and fixed income in 2012, most investors still have ongoing concerns about the stock and bond markets ability to sustain their recent upward trends.
Whether its global issues (European sovereign debt, a China slowdown, the tensions in the Middle East) or specifically within the U.S. (fiscal cliff, corporate earnings slowing or price inflation), there are too many unknown variables, both here and abroad that can negatively impact long-only traditional investments.
In these uncertain times, it is more important than ever to diversify beyond stocks and bonds with alternative asset classes (such as currencies, managed futures and commodities) that have the ability to move independently from stocks and bonds. Historically, alternative strategies have shown the ability to produce positive returns during periods of equity distress and higher interest rates; in other words, when you need them the most.
Over the last few years, alternative strategies have become more accessible to the retail investor through mutual funds and ETFs, allowing investors to allocate more like institutions. The overarching theme with investors continues to be about capital preservation and the need to limit the declines within their portfolio. Regardless of environment, both retail and institutional clients should consider allocating a percentage of their portfolios to alternative strategies as a way to potentially smooth out the overall ride within their portfolios.
Olivier GarrettOlivier Garrett
CEO, Casey Research
Even if the fiscal cliff is averted, the markets in 2013 will continue to be plagued by uncertainty because politicians are unlikely to effectively tackle the budget deficit. Properly addressing it requires Washington to take on the issue of unfunded liabilities, adopt major structural changes, dramatically cut the military budget and finally increase taxes broadly and moderately. Changes will only occur when they are forced to by the markets. The Fed will continue to implement QE5 and QE6 to keep interest rates low and fund the deficit but only as long as Europe, Japan and China are on the same path.
We expect weaknesses in corporate earnings and pressure on stocks prices stemming from contraction in Europe, Japan, and anemic growth in the developing world. Should the fiscal cliff become reality, then the U.S. would experience negative GDP in 2013, at which point political pressure may force a compromise but still no long-term fixes.
Going into 2013 we are short the euro, the yen and Japanese debt. We continue to be long gold. We also favor stocks of non-cyclical multinationals, specifically suppliers of agricultural and food products as well as consumer staples. Selective technology stocks should also perform better than the overall markets.
The U.S. dollar and T-bonds will be okay until markets recognize that the U.S. is not much better than Europe and Japan and the dollar loses its safe heaven status (beyond 2013).
Jonathan HoenigJonathan Hoenig
Co-Founder, Capitalistpig Hedge Fund
Actual criminals enjoy better legal protection than the hedge fund industry. Objective laws and procedures protect the criminal's rights. They're considered innocent until convicted.
But hedge funds are assumed to be guilty from the onset. Because we're motivated by profit, we're presumed to be felons requiring preemptive, wealth-destroying controls. The entire industry is subject to the arbitrary whim of publicity-seeking politicians whose explicit goal is to make our lives harder. "Unregulated hedge funds" my ass.
The JOBS Act continues to shackle hedge funds, not free us. Productive, wealth-producing investors are impaired by the SEC, and the economy suffers—we all suffer—as a result. It's impossible to build a business "for the long haul" with regulators who are literally making it up as they go.
In 2013, the industry must reassert its moral right to exist. Hedge funds are not nefarious shysters; we're traders who deal with others only through mutually beneficial, voluntary exchange. Defending the right to trade, advertise, expand and profit free from government force is the industry's only chance to survive. It starts now.
Daniel J. KingstonDaniel J. Kingston
Managing Director, Investments
Morgan Creek Capital Management
Next year, investors will continue to search for new ways to navigate the increasingly volatile equity markets and deal with the growing challenges of the fixed-income markets, which are not providing enough yield for them to meet their long-term financial goals. In response, we believe investors, particularly institutional investors, will adopt the principles of the endowment approach to investing, which emphasizes a breadth of assets types within a portfolio. At the moment, we think that private-equity investments present a very attractive opportunity. Instead of relying of economic growth for return, in the private equity sector talented GP’s act as change agents to create value.
A common misperception is that the endowment approach is a single-investment prescription. It isn’t. It’s investing with a clean sheet of paper without being tethered to what others are doing. It’s a philosophy of managing risk through diversification, pioneering new sources of return through rigorous analyses and a forward-looking perspective. It’s also recognizing the competitive advantages that one might have in relationship to others. For endowments, that’s an ability to have a long-term investment perspective. Instead of being swayed by the all too common error of myopic, short-term thinking, endowments recognized that their institutional nature gave them an advantage. We believe after years of being too long-term focused, and then overly short-term focused, that more of a balance will return to the markets next year.
By sheer mathematics, a few assets classes will always outperform a diversified approach during any given year. However, it’s not easy to know prospectively which ones will do well. Instead of chasing last year’s hot rocket, investors will focus prospectively on where the opportunity is in 2013, investing for the long-term. By appropriately balancing various time horizons, investors will create well-structured portfolio and achieve steady, compounding returns.
Sal NaroSalvatore (Sal) Naro
CEO & CIO, Coherence Capital Partners
We feel the U.S. is in a slow protracted economic recovery while Europe faces several challenges to economic growth in the short term. Our view is that the U.S. is several years ahead of Europe in dealing with their respective economic malaise.
We remain positive on the credit markets for 2013. Despite the current fiscal cliff anxieties in the U.S., a matter that will ultimately find a resolution, we concentrate on the following market positives moving into 2013: continued strong credit market technicals, increased globally coordinated 2central bank liquidity, China’s economic stabilization, moderate/improving U.S. growth, a calming European crisis for the time being and still relatively attractive market valuations. This, combined with the Fed’s buyback program, will continue to force investors into broader spread product which bodes well for credit and structured credit products.
2012 was a massive year for new issuance. Companies and sovereigns continue to improve their balance sheets by calling and retiring older more expensive debt and reissuing at current levels. Even with all the new issuance the net issuance is actually negative. A vibrant new issue market is the clearest indicator of a healthy credit market. We think the biggest risk to the credit markets in 2013 are rising interest rates.
Bob OlmanBob Olman
President, Alpha Search Advisory Partners
Next year will see more consolidation and closures of underperforming hedge funds, especially in the long-short equity space. Credit strategies including distressed debt, which fared well in 2012, will see additional capital flows from institutional investors looking to replace their current fixed-income allocation with assets that generate higher yield. On the hiring side, we will continue to see a barbell effect, with pay increases going to those fund employees with the best track records, individual contribution and overall lower compensation for everyone else.
In 2013, hedge funds of funds will continue to face competitive pressures and either sell themselves to larger asset management firms or transform into outsourced CIO offices and dedicate their expertise to large institutional investors. In terms of overall fund flows, the largest investors will give more and more of their dollars to the largest hedge funds, who are considered to have institutional-quality organizations with best-in-class risk management and client service. As always, performance will be dictated by how far out on the risk curve these managers are willing to go.
Mark OwenMark Owen
Founder and Director, NBGI PE
The outlook for the start of 2013 is very much flat to down—flat in that everyone is desperately looking for positive signs and does not want to miss an upturn, but down in that there seems little reality behind that hope.
My fear is that whatever consumer confidence remains is being expended in the run up to Christmas, to be followed by...nothing. Without some help from consumers, this may be the year the so-called “zombie companies” finally hit the wall. This will, of course, require action from their banks to finally take the write-downs they have been sitting on. While this will not help banks’ balance sheets, it should allow the majority of such companies to start afresh under new ownership. Such restructuring will be helped by the availability of private equity money versus the shortage of bank debt.
My prediction is therefore for a further set back (a triple-but-final-dip), followed by a more rapid recovery than anticipated, hopefully starting by the third or fourth quarter. Short-term pain for longer- term gain—something that should have happened two-three years ago and has increasingly become a drag on the economy.
Perrie WeinerPerrie Weiner and Nick Morgan
Partners, DLA Piper
Many of the same issues—and a few new ones—will be on the SEC’s hedge fund agenda for 2013. Top two issues: aberrational performance and bounty hunters.
The so-called Aberrational Performance Inquiry, which the SEC touts as employing “proprietary risk analytics to evaluate hedge fund returns,” will continue in full force to drive enforcement investigations and litigation against funds that “outperform market indexes by 3% on a steady basis.” According to the SEC’s annual report issued in November, the SEC brought actions against three firms and six individuals as a result of this effort. Look for even higher numbers in 2013.
Nick MorganWe expect another SEC initiative to get traction in the hedge fund space next year: the Dodd-Frank whistle-blower bounty program pursuant to which the SEC will pay people who provide original information about a violation of the federal securities laws that results in monetary sanctions exceeding $1 million. The SEC announced its first reward in August 2012, and, while most people may associate this program with public companies, we will see rewards in the fund space.
One to watch: the Financial Times reported in December 2012 that a former quantitative risk analyst at a prominent investment bank complained to the SEC that the bank failed properly to value a portion of its credit derivatives portfolio, reportedly resulting in concealed losses of as much as $12 billion.
Looking Ahead: The Hedge Fund Industry Speaks