More Positives for Equity Research

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Increased equity mandates, growing hedge fund assets and humbled momentum players equal more good news for equity research providers.

Increased equity assets

According to a recent article in Pensions & Investments, equities have received growing net inflows from institutional investors.  U.S. and international active equity mandates rebounded in 2013, according to a report released in January by consultant Eager, Davis & Holmes.  In 2013, 373 U.S. active equity hires were made, up from the 305 made in 2012 and the 288 in 2011.

Investment consultant Mercer reported that $431 billion in new assets were committed to equities in 2013.  This was an order of magnitude greater than previous years, which averaged  about $40 billion each year from 2009 to 2012 inclusive.  Comparatively, Mercer saw $1.2 billion go into bond funds in 2013.

Of the investors returning to equities, many are turning toward international equities, particularly those within Europe and emerging markets, which are expected to continue to rise. Data from Eager, Davis & Holmes shows that 291 active international equity hires were made in 2013 — a record high — compared to 271 hires made in 2012 and 210 in 2011. Of these hires, the majority of them — 136 — were in emerging markets equity, also a record high.

The flows into equities have tended to be from new money, rather than a dramatic shift from fixed income.  Most money managers and consultants contacted by P&I agreed they hadn’t been seeing flows coming out of fixed income and into equities as much as they have seen investors reallocating within their fixed-income and equity portfolios.

Momentum strategies punished

At the same time there has been a growing shift away from momentum strategies, and growth stocks, and into value.  According to a recent article in the Financial Times, trend-following hedge funds have suffered further outflows amid weak investment performance, raising questions about their survival.

Commodity trading advisers (CTAs), hedge funds that tend to follow trends in markets using computers to place bets, suffered their 10th consecutive month of net outflows in March, according to Eurekahedge, the data provider.

Overall, investors pulled $5.3bn from CTAs in the first quarter. This follows continued performance difficulties for these funds, which were down 1.8 per cent in the first three months of the year – the worst return of any hedge fund strategy.

CTA funds have experienced losses of 3.3 per cent over the past five years, a sharp reversal from the 11 per cent a year such funds made between 2000 and 2008, according to Hedge Fund Research, the data provider.   Last year the strategy was down 0.61 per cent, Eurekahedge figures show.

Matthew Beddall, chief investment officer of Winton Capital Management, believes that CTAs will need to embrace research more aggressively to survive: “There is nothing about the CTA business model that I see as broken. For CTAs that have invested less heavily in research, I am maybe inclined to say yes. It is just not easy to make money in financial markets, so our saying is: evolve or die.”

Growth in hedge fund assets

Despite troubles in the CTA segment, overall hedge fund assets are hitting new highs.  Pension and Investments reported industry assets hit a new peak of $2.7 trillion thanks to healthy net inflows.

Despite slight dips in aggregate performance in the months of January and March, investment performance and net capital inflows throughout the quarter were sufficient to push hedge fund industry assets to a new peak of $2.7 trillion as of March 31, according to Hedge Fund Research.

The first quarter was the industry’s seventh consecutive quarter of record-breaking net growth, HFR said in a recent research report. The jump in aggregate hedge fund industry assets was the result of the combination of $26.3 billion in net inflows and $47 billion of net investment performance gains.

HFR noted that net inflows in the three-month period ended March 31 were the highest quarterly inflow since the second quarter of 2011 when net inflows totaled $32.5 billion.

If the current pace of new money continues, net inflows for 2014 will top $105 billion, making it the best year since 2007, when net asset growth totaled $195 billion, historical HFR data show.

Equity hedge fund strategies experienced the high net inflows in the first quarter of $16.3 billion, followed by relative value strategies, $11.2 billion, and event-driven approaches, $4.1 billion. Macro hedge funds had net outflows of $5.3 billion, according to HFR tracking data.

Conclusion

Asset owners’ transfer of new assets into equities in 2013 was reflected in the excellent equities markets last year.  Nevertheless, the mandates tend to be relatively sticky, suggesting a continued positive for equities market participants.

Even more bullish for equity research providers is the growth in hedge fund assets, particularly inflows to equity hedge fund strategies.  In their search for alpha, hedge funds are the most aggressive and innovative users of investment research.

Nor does it hurt research providers that CTAs are being pressured to modify their pure quantitative momentum-oriented strategies to incorporate more research.

Combined with the positive commission trends we noted in recent earnings announcements of the large investment banks  the environment for equity research is looking very robust indeed.

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