2019 Hedge Fund Outlook – The Only Way is up?

The new year is traditionally a period to take stock, reflect on the prior year and more importantly, start making predictions. The beginning of 2019 has been no different for hedge funds, as we see many market commentators look to quantify performance in 2018 and take a forward-looking view on themes which may persist over the course of this year.

Bloomberg recently reported that the hedge fund industry saw its biggest annual loss since 2011, declining 4.1 percent on a fund-weighted basis in 20181. Contrary to convention, the increase in volatility experienced in December (traditionally good news for hedge funds), combined with the worst monthly decline in the S&P 500 in over a decade, hit hedge funds, (which had got used to rising asset values after years of easing money policy by central banks), further. Some managers, including smaller, more nimble traders, were able to successfully navigate the market turbulence, but for others it was the worst year ever. Bloomberg argued that this raised the prospects of further capital outflows and undermined the $3.2 trillion industry that is expected to make money through long/short bets designed to profit from large market movements during volatile periods.

Despite the recent downward trend in hedge fund performance, the Financial Times2 reported that funds and prime brokerage providers are taking a positive long-term view on a hedge fund industry that is still growing in terms of assets under management. Although generally one of an investment bank’s most capital-intensive activities, those who focused on prime broking were rewarded in the first half of 2018, when revenues from the activity across the world’s 12 biggest investment banks rose more than 15 percent, according to data from industry monitor Coalition.

Many banks are openly pushing extra resources towards their prime brokerage businesses, betting that their hedge fund clients provide a much-needed revenue boost as other areas falter. The article suggests that despite poor hedge fund performance in the turbulent market conditions towards the end of the year, prime broking divisions still expect the smartest managers to outperform. For example, while losses were being experienced by many traditional long/short funds, fund managers utilizing Artificial Intelligence (AI)/machine learning strategies were up 1.52% in November and 1.43% in December according to the Eureka Hedge AI Fund Index3. This also comes at a time where the banks’ other significant sources of revenue, such as advising companies on mergers and acquisitions or trading fixed income, currencies and commodities, become more and more market-dependent and as such, pose more volatile returns. The Financial Times reported that the final quarter of the year was the quietest period for mergers and acquisitions for more than a year, a sign that market turbulence was giving deal-makers pause. Fixed income trading revenues are also falling, while companies are shying away from doing initial public offerings.

So where does this leave hedge funds in 2019? With financial markets facing continued headwinds and banks looking to push their prime broker businesses forward, it seems likely that investors will not be the only market participants taking a keen interest in the performance of hedge funds as the year continues.

In case you missed it, a recap of recent blog post “Did 2018 have it all for Securities Lending” can be found here.

 

1Bloomberg, January 2019
2Financial Times, Banks raise bets on prime broking for struggling hedge funds, January 2019
3Eurekahedge, Hedge Fund Report, January 2019