According to the HFR Global Hedge Fund Industry Report, volatile financial markets and record losses in equities prompted investors to redeem an estimated $22.5 billion from hedge funds during the 4th Qtr of 2018 – the largest quarterly outflow since 3Q 2016.
4th Quarter Performance
Despite this sharp outflow of assets, hedge funds performed better than the overall market during the final quarter of 2018. The HFRI Fund Weighted Composite Index (FWC) dropped -5.76% during the 4Q18 while the HFRI Asset Weighted Composite Index (AWC) fell -2.73%. This compares to a decline of -16.24% seen in the S&P 500 during the 4th Quarter.
Equity Hedge (EH) funds, led both outflows and weakness in performance during the 4Q18, as investors redeemed an estimated net $16.8 billion, reducing total EH capital to $871.8 billion. The HFRI Equity Hedge (Total) Index fell -8.3% in 4Q while the HFRI Equity Hedge Index (Asset Weighted) fell -5.9% in 4Q.
Partially offsetting the outflow trend, Event-Driven (ED) strategies received an estimated net inflow of $6.4 billion for 4Q, although performance weakness decreased total ED capital to $819 billion from the prior quarter.
Kenneth J. Heinz, President of HFR, explained this performance, “Hedge fund outflows in 4Q were driven by several factors, most notably investor reaction to steep losses in traditional asset investments and the sharp spike in equity market volatility leading to redemptions. However, outflows also included several large fund closures from early 4Q (pre-equity market declines in Oct & Dec), including instances of family office conversions and orderly, manager-initiated returns of investor capital, with all of these representing a stark contrast from the panic-driven redemption from the 2008 Financial Crisis.”
Full Year 2018 Performance
The 4Q18 net asset outflows brought hedge fund capital outflows for the full-year 2018 to $34 billion and decreased total hedge fund capital to $3.11 trillion, down from the prior quarter record of $3.24 trillion.
Despite these outflows, hedge funds topped the steep declines of many equity markets for FY 2018, as the HFRI AWC Index declined -1.0% for 2018, while the HFRI FWC Index fell -4.5% over the same period. This compares to a drop of -6.24% for the S&P 500 Index for 2018.
The HFRI Equity Hedge (Total) Index fell -6.9% during FY2018 while the HFRI Equity Hedge Index (Asset Weighted) fell -5.9% for the year. The HFRI Macro (Asset Weighted) Index posted a FY 2018 return of +1.6%. For the year, the HFRI Event-Driven Index (Total) declined -2.35%, while the HFRI Event-Driven Index (Asset Weighed) fell only -0.6%.
Record hedge fund outflows in 2018 indicate investors’ negative perspective on the asset class. Several hedge funds managed by well-known investors including T. Boone Pickens, Leon Cooperman and Philippe Jabre, either closed their doors and returned capital to investors or converted into family offices during the year – a result of difficult market conditions and increased regulatory burdens. Despite these developments, many hedge funds outperformed the overall markets, suggesting a less bearish outlook on the industry.
These trends are not likely to alter hedge funds’ appetite for unique investment ideas generated by third-party research and alternative data providers. In fact, we would not be surprised if asset managers’ lower research budgets caused by MiFID II won’t encourage sell-side investment banks and independent research firms to focus even more of their energy on marketing their value-added trade ideas to the hedge fund segment.