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Overview: Developed Europe Focused Hedge Funds
The eA|HFN active and inactive databases have performance and asset information for 204 unique funds that invest primarily in developed European markets. There are an additional 317 funds which invest broadly across all European markets. The latter may have large exposure to developed markets, but are kept separate to ensure the prior group is a pure representation of developed Europe focused strategies.
•In the midst of the sovereign crisis in the Eurozone, funds investing in developed Europe have performed relatively well in 2011, -4.67% vs. -13.92% of the Stoxx Europe 600, however most lag the aggregate hedge fund industry.
•Investor interest in developed and broad Europe focused funds has been below average. Funds have had an estimated net outflow of $1.8 billion in 2011, or 1.0% of total AUM vs. 2.8% growth for the hedge fund industry.
•On a regional basis, developed Europe focused funds have had the highest rate of combined liquidations and non-responsive fund delistings in the HFN database.
The European sovereign debt crisis has been a slow developing fiscal mess which has severely hurt investor confidence. Hedge funds investing in these markets appear to have been defensively positioned, but there are still pockets of large losses. The remainder of this report will look at the sub-groups of funds investing in the region to see if outperformance of regional equity markets appears to be tactical or if it is more a factor of breadth of strategies and smoothed aggregate performance.
Developments in European Markets and Impacts on HFs
The European sovereign debt crisis has had global market implications, but the effects on European equity markets and hedge funds that focus on them has been direct in terms of relative performance, investor redemptions and liquidations. Following are highlights from the eVestment | HFN database on those funds focused primarily on developed European markets.
•Last twelve month percentile rankings of equity focused developed and broad Europe funds has lagged other developed equity market exposures at all data points.
•Figure 5 illustrates to what extent developed Europe fund performance has tracked the severity of the sovereign debt crisis as characterized by the spread between Greek and German two year sovereign yields. September appears to be another difficult month as the spread nearly doubled and the Stoxx Europe 600 was down almost 10% before the month end rally.
•The eA | HFN database has recorded a 12.4% decline in developed Europe focused funds due to liquidations and non-responsive fund delistings in 2011, nearly double that of broad Asia focused funds and 1.8x higher than North America funds.
•30% of developed Europe funds reporting through August are positive YTD. If September results are similar to August, less than 20% of funds will likely remain in positive territory. Of those reporting through August, 42% are down more than 5%.
•There is virtually no difference in average YTD performance for UCITS structured developed Europe focused funds and those not structured as UCITS.
•Despite above average investor outflows and performance losses, developed Europe focused funds remain larger on average than N. America funds ($212mm vs. $206mm), both of which dwarf the average size of Asia focused funds ($130mm).
There are pockets of positive returns amongst developed Europe focused funds, however no single sub-sector appears to be keeping its head above water. The implication being that positive returns are driven more so by the quality of management than environment. There is a proportional mix of credit, equity and commodity (power markets) funds among those up for the year.
Total Asset Levels
eA | HFN tracks AUM for funds investing across all European markets, including emerging Europe, but has not previously estimated flows for those investing solely in developed Europe. By backing out estimates for emerging Europe we can estimate flows for funds investing solely in developed Europe and broadly across all European markets, the latter being predominantly focused on developed Europe:
•AUM in funds investing across all European markets was estimated at $220.7 billion at the end of August 2011, down from a pre-2008 crisis peak of over $400 billion.
•At the end of August, HFN estimated emerging market Europe fund AUM of $44.8 billion and therefore an estimated $175.9 billion in AUM in funds investing primarily in developed broad European markets.
•Approximately ? of the combined AUM, or $44 billion is invested solely in developed European markets.
•Investors have withdrawn an estimated net $1.8 billion from Europe non-EM focused funds in 2011. This follows net redemptions of $13.3 billion in 2010.
•Redemptions in 2010 began in earnest in May ($10.7 billion net redeemed in May/June 2010) coinciding with the first major spike in European sovereign yields.
The investor flow data paints a very clear picture that investors have been actively reducing exposure to European markets, on an aggregate basis, since the first major fears of a sovereign default in the Eurozone. The rates of redemptions have slowed, but persisted in recent months.
Performance Comparisons by Region/Country
Developed Europe focused funds generally invest across many Eurozone markets; however there are a number of funds which invest either primarily in the U.K., or in Nordic markets. U.K. funds operate almost entirely in equity markets whereas Nordic funds have concentrations of funds trading regional power markets, mortgage bond and the equity markets.
Figures 8 and 9 and the table above show the performance of these funds and their sub-market classifications and performance of other developed country specific hedge fund exposures and equity benchmarks.
•Despite being primarily equity market oriented, U.K. focused hedge funds have performed very well compared to the FTSE 100 Index, however both are in negative territory mostly due to August returns. In September, the FTSE lost an additional -4.93%.
•Nordic equity focused managers have performed very well compared to regional EQ benchmarks. The credit related strategies have fared worse. Performance from these funds has been weighed down by those with leveraged exposure to Danish mortgage bonds.
•Canada focused funds are the only country specific group which has been unable to outperform the relevant equity benchmark in 2011.
Performance by Primary Strategy in Developed Europe
Funds investing in European markets typically fall into one of five primary strategies; Long/Short EQ, Market Neutral EQ, Event Driven, Credit and Multi-Strategy. Figures 9 and 10 and the table on the following page illustrate the relative performance of funds utilizing these strategies in developed European markets to their counterparts operating primarily in other developed market.
•There is a high concentration of funds investing the Danish mortgage market in the developed-only credit group. These funds appear to have suffered after the Basel III proposal determined the bonds would have a limited role in bank holdings as liquidity instruments.
•The classification of broad European credit funds, which have performed more in-line with other developed market credit funds, is more indicative of developed European credit expsure, however their descriptions of regional orientation tend to be more open ended.
•European market neutral equity and event driven strategies have lagged their developed market counterparts by a wide margin in 2011.
•Long/short equity funds have been in-line with North America focused strategies. Asia/Pac long/short funds have performed noticeably better in 2011.
The last page of the report contains full correlations of monthly returns between regional primary strategies and both equity and hedge fund benchmarks over various time frames.
Going Forward
Among the high concentration of equity focused managers in developed European markets, there appears to be a pronounced defensive positioning which has led to the large outperformance during recent market declines. Early indications for September show an average return of -1.38%, compared to a decline of -4.78% in the Stoxx Europe 600, however this may drift lower as more funds report. Combined developed and broad Europe funds are -0.54%.
In the longer term, it is difficult to ignore the consideration that amid this crisis there may be massive value and opportunity being created, similar in concept to the environment mortgage related strategies realized post-2008 financial crisis. The declining rates of net outflows in recent months may be an indication that allocations may be beginning to return in anticipation. Where and when opportunities will be available are obviously the key, but chances are there will be hedge funds at the forefront.
HFN will publish Europe focused fund flows estimates in the both the early performance release due out Tuesday October 11th and in the Monthly Industry Report the week of the 24th.
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