Hedge Funds’ Annus Horribilis | Chief Investment Officer

2014 was the worst year for hedge fund managers, regardless of their skill, according to analytics firm Novus.

Like an expert fisherman facing an empty lake, hedge fund managers found historically low rewards for their abilities (if any) to outperform indices.

“In 2014, a portfolio manager could have been just as good at timing the market, or picking winners and losers, or sizing those positions effectively as she’d always been, but the returns from an alpha-generation standpoint won’t show it,” said Joe Peta, managing director at Novus.

Novus1 Source: Novus

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According to Peta, tactically shifting net exposure to a stock proved ineffective due to low volatility. Daily average realized volatility for the S&P 500 declined for three consecutive years to just above 50%—well below the 10-year average—the firm’s data showed.

A hedge fund manager’s ability to pick stocks also added little value in 2014, Novus said, as securities hugged the benchmark, resulting in a tight spread in performance.

Like volatility, the spread between the average outperformer and underperformer in the S&P 500 hit a multi-year low at just 31.6%. The 10-year average, in comparison, was 42.6%.

“The ability to pick winners and losers beforehand, the skill of relative-value pairing, which is the very basis for the theoretical value of superior risk-adjusted returns in a long/short hedge fund, has almost certainly never been worth less during the existence of virtually every hedge fund,” Peta said.

Furthermore, the ability to size positions efficiently failed to add much value in 2014, Peta said. The spread between the top and bottom half of S&P 500 outperformers were just 29.9%, according to Novus, while the difference for underperformers was even lower at 21.6%.

“Position sizing is valuable in an environment where there is wide disbursement within the winners and losers, as opposed to between the winners and losers,” Peta said.

Such market environments contributed to a five-year high of hedge funds closures last year. A total of 904 hedge funds closed in 2014, according to HFR, with funds returning an average of 5.5% while the S&P 500 gained 12%.

Most recently, hedge fund tycoon Paul Tudor Jones announced his firm Tudor Investment Corporation is closing its $300 million futures fund due to high operational costs.

Jersey-based Brevan Howard also posted its first annual loss in its flagship $24 billion macro hedge fund last year, ending an 11-year winning streak, according to the Financial Times.

Sources familiar with the company told the news organization that the fund recorded a loss of 0.8% following a steady decline in returns the past few years.

CNBC also reported that Guggenheim Partners had fired at least eight senior executives from the firm’s $600 million hedge fund unit last December. Insiders said the main fund’s mediocre performance contributed to the layoffs.

Novus2 Novus3 Source: Novus

Real assets funds are becoming larger as established managers increase their market dominance across the real estate and infrastructure sectors, according to data from Preqin.

Real estate funds that closed in 2014 raised $90 billion in aggregate, Preqin reported, down marginally from the sector’s 2013 total—although additional data is expected to push the total above $100 billion, the data firm said.

“While fundraising is likely to be strong in 2015, we expect that capital will continue to be concentrated into a small number of funds.” —Andrew Moylan, PreqinHowever, the assets were spread across far fewer funds: 177 real estate products closed successfully last year, compared with 239 in 2013. In 2012, 263 funds closed with $69 billion raised.

In infrastructure, the data showed a similar trend. Funds raised a total of $38 billion, down from 2013’s total of $44 billion, while the number of funds closed fell from 69 to 42.

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This has pushed the size of funds up across the board, with the average real estate portfolio rising to $528 million, while infrastructure products averaged more than $1 billion for the first time since 2007.

Andrew Moylan, head of real assets products at Preqin, said fundraising was likely to remain “highly competitive” this year as investors become more discerning about the fund managers they select. This meant managers “must make a compelling investment case to attract capital”.

“Investors are becoming far more sophisticated in how they invest in infrastructure, with many increasingly targeting direct investments or co-investments,” Moylan added. “While fundraising is likely to be strong in 2015, we expect that capital will continue to be concentrated into a small number of funds.” Infrastructure, Real Estate Sectors' Historical Fundraising Source: Preqin

Blackstone’s Real Estate Partners Europe IV fund was the largest close in 2014, raising €6.6 billion ($7.8 billion) as demand for European assets soared. The largest infrastructure close raised $5.1 billion for the Energy Capital Partners III fund.