The COVID-19 pandemic has changed the way hedge funds do business, from raising money to investing and more. Some trends are here to stay, while others will change as the pandemic continues and eventually comes to an end.
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Active management is back
Craig Bergstrom, chief investment officer at Corbin Capital Partners, said in an email that active management had returned in 2020, especially fundamental stock selection. He said results across the industry are mixed, but dispersion has meant that careful portfolio construction has been precious.
"Broad hedge fund performance has certainly been disappointing in recent years," Bergstrom said. "Very low interest rates are a big part of that problem, but clearly another key factor is fund fees, which have come down, but not fast enough, which means they are consuming too much of the gross returns."
He adds that it's not fair to compare hedge fund returns to stock market returns because it is nearly three times as volatile. However, in recent months, investment managers have finally started to have an easier time generating alpha.
"The right hedge fund portfolio, though, has been able to deliver solid alpha, and attractive risk adjusted returns, which we think remains very attractive in a world where prospective fixed income returns are very low," Bergstrom said. "Investors have been uber focused on performance, but that means they chase returns; they're pulling money away from laggards and giving money to strong performers, so dollar weighted returns are often far worse than reported."
Fundraising capability is a "pedigree" issue
One of the issues some funds have had this year is raising funds. Bergstrom said big firms have continued to get bigger, while small firms are having a more challenging time raising money. Jason Meklinsky of Apex Group called the success of hedge funds in raising new money "a pedigree issue."
"There is an exaggerated gulf between the fundraising success of managers with good record of accomplishment, and their less established peers," Meklinsky said in an email interview. "These funds have a better than average chance of a 'critical mass' launch. As a result, we are seeing inflows to funds at both the large cap and boutique ends of the market, with mid-sized funds and those lacking a strong pedigree struggling to attract investors."
Apex has seen a slowdown in the amount of funds being raised and that the overall average launch size of funds is down year over year. Meklinsky said overall sentiment on allocation to hedge funds is positive for the coming year, but it's also overshadowed by the industry's disappointing performance over the last 12 months.
Remote working is a challenge that's here to stay
Both Bergstrom and Meklinsky talk about the challenges firms face with the pandemic having shut down many offices. Bergstrom said having to develop relationships remotely has taken a bite out of fundraising for smaller funds.
"Developing new relationships in this environment is hard, though seems like there is increasing comfort among allocators to remote/video meetings and interactions," he said. "On the operating side, hedge funds are facing the challenge of balancing remote vs. in person work. Working virtually is not perfect but it is definitely working, so will likely be a bigger part of the industry going forward. On the other hand, many of the investors we admire most have been focused on being back in the office, so there will be a balancing act to manage."
Meklinsky said the pandemic has slowed down the due diligence process for funds. Meanwhile, many managers are looking to control costs.
"Exacerbated with remote working, funds are expressing a desire to move most non-investment activities' off premises,' due to the benefits they see in terms of cutting overall expense to the manager, and the ability to be flexible and scale up or down as required at any time in the funds' lifecycle," he says. "Of course, as in other asset classes, the pandemic has slowed down due diligence processes for funds. In addition to the wider economic landscape, the regulatory regime for both U.S. and non-U.S. vehicles is currently expensive to operate within, especially at a time when funds are looking to control costs."
Looking into 2021
The pandemic has likely changed the fund industry forever. Bergstrom thinks remote work is here to stay.
"It seems likely that we will have more remote working, given how effective it can be, though I still look forward to having my team together in person," he said. "I also suspect that video will replace at least some travel. If we are seeing clients in person less, we will focus on improving our digital communications and be more creative about how we share ideas and content."
In the new year, Bergstrom hopes that investment firms will continue to generate alpha and that hedge fund trends will be positive.
"We are hopeful that continued higher volatility and dispersion creates opportunities for fundamental managers to perform well and generate alpha, though we spend a lot more time thinking about how to position our portfolios to provide attractive risk-adjusted returns even if hedge funds are underwhelming," he states.
ESG in 2021
Another trend that could continue for hedge funds in 2021 is the push toward ESG (environmental, social and governance) issues.
"We've been extremely focused on ESG and how managers we work with are approaching it," Bergstrom said. "Hedge funds have lagged other parts of asset management when it comes to ESG, but we think it will become more widely integrated in the HF business in 2021."
He adds that climate change is a central concern as both a risk and an opportunity, but Black Lives Matter and diversity, equity and inclusion are also important.
