New Year to Change Hedge Funds

By James Armstrong, Hedge Fund Correspondent

By James Armstrong, Hedge Fund Correspondent

The New Year is likely to see several important shifts in alternative investing, according to Don Steinbrugge, managing partner of Agecroft Partners, a global consulting and third-party marketing firm for hedge funds.

Steinbrugge said during the fourth quarter of 2008, investor demand started to shift toward market neutral strategies, as well as toward strategies that used little leverage and provided investors with transparency and liquidity. That shift will likely continue throughout 2009, he said.

Short-biased funds, which have always been a small percentage of the marketplace, surged ahead in 2008, delivering double-digit returns and capturing a larger market share of alternative investments. Steinbrugge said investors are likely to continue to invest in short-biased funds, but their growth will be at a slower pace than last year.

Commodity Trading Advisors (CTAs) are likely to see a lot of demand as well, as they also delivered double-digit returns last year and proved they are not correlated with other hedge fund strategies. Steinbrugge said, however, that does not mean traditional long-short equity funds are on their way out.

"Long-short equity funds have actually done pretty well in comparison to the S&P 500," Steinbrugge said. "I don't think you'll see a huge shift out of long-short equity."

Steinbrugge sees the next two quarters as being a lot better from a fundraising standpoint for hedge funds. A lot of funds are shutting down, either because of investor redemptions or because managers have fallen so far below their high-water marks it does not make sense for them to continue their funds from a business perspective. Also, a lot of investors have moved to cash. Eventually, all of that excess money needs to be deployed, and talented managers with attractive strategies could benefit.

That does not mean everything is coming up roses for hedge funds. Steinbrugge predicts the hedge fund industry as a whole will continue to shrink at the beginning of the year, though its decline will be smaller than in 2008. By the end of the year, the industry will be stabilized, he said, but likely somewhat smaller than it is now.

"By the first or second quarter, we're going to reach a low point in assets, and I think after that, you'll see the industry begin to grow again," Steinbrugge said.

Institutional investors will continue to become a larger percent of the market for hedge funds, according to Steinbrugge. While many high-net-worth investors have been clamoring for the exits, institutions have taken a look at their portfolios and seen their hedge fund managers have significantly outperformed their long-only equity managers.

"In the fourth quarter, I think a lot of institutions put their increased allocations on hold," Steinbrugge said, but he noted they generally did not reduce them. "I think you'll continue to see those allocations increase next year."

If he is right, the hedge fund industry in 2009 might be somewhat smaller than it was last year, but it could have a much more institutional face.

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Jan. 2, 2009