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 macro environment and credit markets to hedge fund fees the rise of retail investing.
Shad AzimiShad Azimi
Managing Partner and Founder
There are several underlying forces driving the growth of the secondaries markets: 1) accelerated use of secondaries for portfolio balancing; 2) consolidation amongst asset managers; 3) regulatory pressures on financial institutions, particularly with European banks; 4) strong liquidity desire by LPs in mature or underperforming funds.
In the secondary private equity market, we will see a significant increase in deal flow and transaction volume. That said, U.S. and European banks need to address new regulatory requirements, while large endowments and pension plans are strategically rebalancing portfolios. From a buyer’s standpoint, secondary offerings have potential benefits over traditional primary investments. These assets often have shorter holding periods, extensive due diligence from sell-side and buy-side advisors and a quicker return of capital. The current dynamics between the supply/demand curve in secondary offerings create favorable conditions for buyers. We think that North America will dominate the secondary market in deal flow with plenty of sellers and buyers. European banks will also need to shed private equity assets, while the Asian market is still in the early developmental stage in terms of supply.
As much as $100 billion of the $1.5 trillion currently invested in private equity is stuck in 'zombie funds'—near-dead private equity funds that linger beyond their target lifespan, generally 10-12 years. While the problem is large now, we expect it to grow even more in the future with zombie assets likely to reach $500 billion over the next several years. Institutions are now actively trying to deal with the problem, for example, in June, CalPERS began selling $200 million in zombie funds that hold venture capital investments in start-ups. This growing pool of assets will provide attractive investment opportunities, whether through acquisition of direct underlying assets, acquisition of LP interests in older funds, or fund restructurings in partnership with the incumbent GPs.”
Chief Risk Officer, RBR Capital Advisors
We view the European landscape as a continuation of the bifurcation between economies, which is very different to the perception of Europe just a few years ago. Whilst we expect some of the structural reforms to put countries like Spain eventually in a better place than Germany, this will take time and the recession will continue into 2013. So we expect a rise in many deep value peripheral companies as investors will be disappointed by the current hunt for dividend yield and dividend growth.
There will be much scope for a strategy that employs a dividend arbitrage strategy. High dividend-yielding companies for the most part are now richly valued, especially in the healthcare and pharma space, which, as our CIO puts it, is “where innovation has turned out to be more hype than reality” and which has seen a strong performance throughout the year. We see the case for deep-value dividend growers. Liquidity pumping by the central bankers is sure to continue to give a boost to the banks as it is the primary place for the economy to begin the healing process, via credit. German real estate is finally showing signs of an upward trend and we expect this to continue. So brace yourself for another rocky ride in 2013, as the strategy that we believe continues to make sense is long-short Europe!
Jerry HaworthJerry Haworth
Principal and CIO, 36 South
‘The Great Game’ will continue in 2013; global credit deleveraging verses central bank money creation. But artificial prices, interest rates and volatility will have some unintended consequences. My guess…stagflation. What you “have” goes down in price, what you “need” goes up in price. The ultimate wealth destruction machine! (Unless you know how to position your portfolio correctly.)
How to position your portfolio? Current thinking overweights bonds. We believe current investors are being corralled into the 'bond abattoir' by the preponderance of fear in the markets and overpaying for safety. Sometimes, like in a zebra herd, the best place to be is in the front; i.e., counter-intuitively in a place where it seems riskier but is in fact safer. What is this place? Equities.
China—black box for reliable data. Europe—I expect the periphery countries in the European Union to show the way next year as they have the least to lose. USA—kicking the can down the road. Overall—black swans are roosting on the roof as we grapple with the 'nine-headed hydra' of debt and deflation. Expect the unexpected.
Irwin KishnerIrwin Kishner
Executive Committee Chair, Herrick, Feinstein
Private equity activity is going to pick up on a number of fronts in 2013. There has been a significant storage of liquidity over the past year and firms have been holding out on the sidelines. [Now that we are past] the fiscal cliff, there will be an up-tick in activity. That’s not to say that there wasn’t any activity in 2012—in fact, 2012 saw a decent amount of deals. Next year, however, will be even busier as I expect an increase in M&A in general, including in the private equity arena, particularly in the middle market.
Whenever you’re entering a cycle heading out of a recession and into a more robust business environment, the industry verticals that tend to do well include manufacturing, heavy machinery, automotive and retail. These are core areas where we can expect to see more activity on the private equity investment side. Typically, when there’s more optimism within the economy, private equity tries to get in on it before it really kicks up. In the next three-five years, we’ll see a more robust U.S. economy coming out of the recession that resembles the mid-2000s—a time of real economic activity.
On the domestic front, there is an increased awareness of opportunities in the marketplace, and as macro issues like the fiscal cliff and the Eurozone crisis reach points of resolution, we will see more deal activity.
Peter LaurelliPeter Laurelli
VP and Head of Industry Research, eVestment
At eVestment, we have the unique ability to gauge demand for exposures and strategies not just from data reported by fund managers, but also by monitoring investor search activity in our analytics, and listening to the demands for various products from our institutional clients. We know the mandate to allocate to the hedge fund space remains strong, so we fully expect net inflows to continue into 2013. Where flows will go is slightly harder to predict.
With almost record flows into credit strategies during 2012, it is hard to think the space has not reached a tipping point. Credit exposure provided strong relative returns in 2012 amidst a volatile market marked by tepid global growth. Heading into 2013, many question marks still exist. What credit markets provided hedge funds in 2012 were price dislocations and opportunities for those with the flexibility to act, the expertise to assess underlying fundamentals, security and capital structure, and related derivative instruments. The possibility of value to be realized in either a positive or negative direction, based on deviations from actual fundamental or relative value due in part to an unpredictable macro environment, has proven to be of interest to investors. Alternatively, when these same factors play an equally major directional role in broad equity market movements, it has proven harder for fundamental valuations to be realized.
For this reason, we believe investors will likely continue to allocate to the credit space into 2013, and equity fund flows will continue to lag despite credit funds receiving what seems to be an unsustainable flow of assets. However, this trend is hardly irreversible. If question marks can truly be removed and fundamental and market forces can once again become the primary catalysts in equity markets, then investor flows should return. The demand for the robust returns equity strategies have produced in the past is absolutely present, but the willingness to accept exogenous risks is low.
Don SteinbruggeDon Steinbrugge
Chairman, Agecroft Partners
As pensions struggle to enhance returns to meet their actuarial assumptions, we will see an increase in the speed of the evolution of pension funds’ hedge fund investment process.
Historically, many pension plans started with an investment in hedge funds of funds, followed by hiring a hedge fund consultant and investing directly in typically the largest hedge funds with the strongest brands. As they increased their knowledge of the hedge fund industry and added to their internal research teams, they began to make more independent decisions and focused on “alpha generators” which include mid-sized managers. Finally, they evolved into the “endowment fund model” or best-in-breed strategy of investing. In the final stage, hedge funds are no longer considered a separate asset class, but are incorporated throughout the pension fund portfolio. This whole process used to take over a decade; however, recently, some of the larger pension funds have begun to skip the first step of investing in hedge fund of funds by investing directly in individual hedge funds. This will have long-term implications for the hedge fund of fund industry. In addition, we are seeing an increasing number of pension funds utilizing hedge funds in different areas of their asset allocation.
Cole WilcoxCole Wilcox
CEO and CIO, Longboard Asset Management
After two years of directionless volatility, global markets are likely to see a return of trending markets in 2013. We believe that worldwide equity, fixed-income, commodity and currency markets will start to show new life as the recent cyclical drought of directional trends ends in the year ahead. This likely resurgence should benefit long-term, trend-following strategies and the managed futures asset class as a whole.
Bob WorthingtonBob Worthington
President, Hatteras Funds
Given the strong rebound of risky assets since March 2009, we at Hatteras Funds believe investors should apply a carefully constructed and balanced approach to asset allocation for 2013 and beyond. While it is inherently difficult to predict capital market movements, we believe investors should consider increasing their hedged positions for the year ahead.
There are many global factors that could derail the recent bull market including the continued European debt crisis, U.S. fiscal concerns that may not end with the “fiscal cliff,” and structural adjustments in China and India. Each of these factors could result in declining global GDP growth. Today investors have access to a greater array of investment strategies than ever before. Investors are able to gain broad market exposure inexpensively and access alternative strategies in daily liquid vehicles.
We believe investors should consider reducing their exposure to long-only, unhedged equities and high-grade fixed income in exchange for alternative strategies. We see opportunities in long/short debt strategies, managed futures and believe that exposure to experienced long/short equity managers could be beneficial for investors in the future. These alternative strategies offer investors the potential to generate positive returns and provide downside protection in a volatile market.
Finally, for the long-term, exposure to both hard and soft commodities remains an attractive allocation, as the growing wealthy and middle class around the world, especially in the emerging economies, will drive the demand for these products and continue the long-term trend of increasing prices. In addition, for those investors who have access to quality private equity, we believe there is great investment opportunity as entry points are attractive in certain markets, such as Europe and Southeast Asia.
Looking Ahead: The Hedge Fund Industry Speaks