Dramatic increase in hedge fund inflows raises overheating fears - 08/07/01
Hedge fund inflows last quarter were greater than those for the whole of last year.
Another $8.4bn found its way into the industry last quarter, pushing half-yearly inflows up to a massive $15.3bn, according to figures from London-based Tass Research.
The figures will add fuel to claims that the hedge fund industry is overheating. Barton Biggs, a Morgan Stanley Asset Management strategist, has been the most prominent observer to claim that the hedge fund industry is showing bubble-like characteristics.
Hedge funds started to really take off last year when it became clear that the stock market was not going to bounce back quickly. Boosted by their ability to hedge and short stocks, hedge fund performance has beaten various stock indices. By the end of last year, hedge funds as a group had notched up a return of 4.8 per cent, while the MSCI SAFE index, which tracks international equity performance, was down 15.2 per cent, the Standard & Poor's 500 index was down 10.1 per cent and the technology-heavy Nasdaq was down 39.3 per cent.
At the beginning of this year investors took advantage of long-short equity returns, looking for a souped-up version of the equity performance that had served them so well up to 2000. Long-short equity hedge funds notched up a 2.1 per cent return last year - much higher than most equity indices.
As a result, long-short equity strategies experienced inflows of $3bn, 40 per cent of the $6.9bn that went into all hedge funds in the first quarter.
This quarter, however, hedge fund investors seem to have caught on to the idea that they can do better elsewhere in the hedge fund universe. It became clear, as the listless equity market progressed, that equity hedge funds might perform better than the equity market as a whole but they are still tied to the fortunes of the equity market. Long-short equity funds as a whole are down 3.39 per cent in the year to date, according to the CSFB/ Tremont indices, while hedge funds as a whole are up 2.13 per cent.
"Quality managers in that space can be tough to find," said Nicola Meaden, director of Tremont Advisers. But she added that she thought the balance between hedge fund sectors had changed for other reasons: "I think it is more about investors' appetite for other sectors." Long-short equity roughly tied with event-driven strategies this quarter for the largest inflows. Event-driven managers reaped $2.94bn of new money, while investors ploughed $2.84bn into longshort equity. Tass includes both merger arbitrage and distressed funds within event driven but the majority of the new money is going into distressed investing. The slowdown of the merger market has squeezed merger arbitrage returns. Other big winners were convertible arbitrage, which experienced inflows of $2.4bn, and fixed-income arbitrage, which attracted $461m in new money. Fixedincome arbitrage is only now emerging from the cloud cast by the near collapse of Long-Term Capital Management in 1998. And JWM Partners, John Meriwether's new fund, was one of the biggest new beneficiaries of investors' love for bonds.
Bubble pundits will doubtless point to the size of the figures to support their point of view. But even these strong numbers are insignificant when compared with the mutual fund industry. There is about $5,000bn under management in US mutual funds, compared with an estimated $40obn in hedge funds. And roughly $90bn flowed into mutual funds through the first half of this year, compared with hedge funds' $15bn.
A better indication of whether there is a hedge fund bubble comes from looking at the strategies themselves. Even with longshort equity inflows at high rates, it is difficult to argue that hedge fund money is ever going to swamp the massive equity markets.
The same might not be true of the distressed, convertible arbitrage or bond arbitrage markets. Already hedge funds are said to be buying a massive proportion of new convertible bond arbitrage, and second-quarter convertible bond funds' performance seems to have suffered from falling equity volatility.
The distressed market is better favoured in that record levels of US high yield are being downgraded or defaulted on and distressed funds have had a quiet decade.
"I don't think liquidity is an issue at this stage," said Ms Meaden. "Distressed has been under-funded for many years and out of fashion."
Nevertheless, capacity constraints drove Long-Term Capital Management to its worst excesses and it is in these narrower markets that the bubble might explode.