Why Your (Smaller) HF Manager Might Not Be Worth the Fees

Despite expectations of more unorthodox portfolios, smaller hedge fund managers may be investing in the same popular securities as larger managers, according to analytics firm Novus.

The firm’s data showed both large and small managers held the same percentage of non-unique securities (8%), indicating smaller managers choosing more common stocks than expected.

In addition, the data revealed a large majority (92%) of managers invested less than half of their portfolios in the most common stocks. Of these managers, nearly a third held less than 10% of their value in common stocks, the report said.

Novus HF Fees3 Source: Novus

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“The argument that hedge funds are all doing the same thing can be positively debunked,” said Stan Altshuller, Novus’ co-founder and chief research officer. “The percentage of unique and non-unique managers today is almost the same as it was in 2007.”

Hedge funds that are “simply following the crowd” are not worthy of high fees, the report said, and may have reduced abilities to liquidate stocks quickly. Most frequently owned securities also tended to underperform market benchmarks, Novus added.

“You’re better off holding an ETF than buying the most popular hedge fund stocks,” Altshuller said.

Instead, investors should examine to the composition of managers’ portfolios to determine “worthy” hedge funds—those deserving their high management and performance fees—and thus consider qualities beyond past performance, Altshuller said.

“A unique portfolio indicates original research and independent analysis,” Altshuller said. “When this concept is coupled with consistent outperformance, it strongly indicates reliable skill and unique alpha generation—that more than justifies fees.”

Using proprietary data, the analytics firm identified RA Capital Management, Perceptive Advisors, and Baker Brothers Advisors as unique managers with the highest performance over the past three years.

Novus HF Fees2 Source: Novus

A rise in the oil price and a weakening dollar hurt managed futures and macro hedge funds in April, according to data from eVestment.

Managed futures funds lost 0.67% on average in April, the sector’s first monthly loss since October, the data group said, with funds of more than $1 billion losing 3.62%. This followed eight consecutive months of gains, which had brought strong asset flows into the sector. In the first quarter of 2015, managed futures funds saw inflows of almost $10 billion, one of only three sub-sectors of hedge funds to post significant inflows.

Global macro funds lost an average 0.65% last month, and the sector was the poorest performing segment in the first four months of the year, gaining just 0.27%.

Despite these results, hedge funds enjoyed a strong month overall in April and have on aggregate outperformed the S&P 500 index so far this year. Last month’s aggregate gain of 1.22% brought the hedge fund industry’s return to 2.92% for the first four months of 2015, while the S&P 500 rose 1.93% between January and April, eVestment said.

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The data provider said hedge fund managers “may be showing their mettle” amid financial and geopolitical volatility.

“It’s easy to undervalue the importance of hedge fund strategies and active management in general during the kind of bull market we’ve enjoyed for the last few years,” said the report’s author Peter Laurelli, eVestment vice president and head of research. “It’s when things become less certain and more volatile that hedge funds really show their strength for investors looking to diversify with a variety of investment types as they seek to grow and protect their assets.”

In the first quarter of 2015 hedge funds have recorded aggregate inflows of nearly $30 billion, more than a third of the total inflows recorded during 2014. Total asset under management were $3.1 trillion at the end of March, eVestment said.

Hedge fund flows (source: eVestment) Source: eVestment