Hedge Fund Outlook 'Stable'
Friday, March 25, 2011

The 2011 credit outlook for hedge funds is stable overall, with signs of improvement underpinned by the industry's positive performance and profitability, says Moody's Investors Service in an Industry Outlook.

Moody's report highlights that the hedge fund industry has registered strong performance since the latter part of Q3 2010, which has resulted in renewed market confidence and net investor inflow.

Odi Lahav, a Moody's Vice President and Senior Credit Officer says "the current economic environment and the likelihood of a protracted recovery in the US and in Europe favour flexible investment mandates, and as such, hedge funds are well positioned to increase their respective share of global investment capital".

Moody's suggests that the financial environment is likely to remain volatile, but the ratings agency expects the favourable trend to continue in the short-term, barring a major market event.

The report also notes that the downturn and post-crisis environment has resulted in structural shifts amongst several hedge fund industry stakeholders, particularly pension funds and banks. Lahav adds, "institutional investors, particularly pension funds, are likely to materially increase their allocations to hedge funds and other absolute-return vehicles."

Changes in the composition of the investors base, which are perceived by Moody's to "positive," could however lead to strategic challenges in relation to distribution, product development and market positioning. Despite these issues, Moody's outlook for hedge funds' operational quality is optimistic as investor demand and regulation of hedge funds result in hedge fund managers paying closer attention to their operational infrastructures.

In terms of performance this year, hedge funds have delivered solid, if unspectacular returns, and have generally lagged the boarder equity market benchmarks.

The Dow Jones Credit Suisse Hedge Fund Index, which is constructed from a database of more than 8,000 hedge funds, rose 1.38% in February, with eight out of ten sectors posting positive performance for the month.

The Hennessee Hedge Fund Index, which tracks 3,500 hedge funds, advanced 1.43% in February and is up 2.15% year-to-date.

By comparison, in February, the S&P 500 advanced 3.20% (up 5.53% year-to-date), the Dow Jones Industrial Average increased 2.81% ( up 5.61% year-to-date), and the NASDAQ Composite Index climbed 3.04% (up 4.87% year-to-date).

Lee Hennessee, Managing Principal of Hennessee Group, attributes hedge funds' muted performance to "conservative portfolio positioning" so far this year.

“While most believe that the economic recovery will continue, the market’s strong rally over the past two years has priced in a lot of positive news. Thus, many managers are cautious and are willing to sacrifice some upside participation in order to be protected in case of a correction," Hennessee said.