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2012 Hedge Fund Outlook: Investors Expect Bright Year After Stormy 2011

Despite a difficult year in 2011, experts predict hedge fund assets should reach pre-crisis levels this year as investors bet big on the sector.

A sense of optimism is pulsating throughout the investment community over the hedge fund industry's prospects in 2012, even as the sector remains bedeviled by the same obstacles that hampered its performance a year ago.

The second half of 2011 was brutal for hedge funds, with many buckling under the weight of the sovereign debt crisis in Europe, a sagging U.S. economy and wild day-to-day gyrations in the global markets. Quantitative-based hedge funds were hit particularly hard by rampant volatility throughout the latter half of the year, experts say. Overall, 40 percent of investors saw lower-than-expected returns in 2011, mirroring what they took home in 2008, according to a survey conducted by market data provider Prequin.

Along the way, many hedge funds ultimately decided to throw in the towel, with Asia seeing the most closures since the financial crisis first hit in 2008. There were a number of high-profile closures in the U.S. as well, with firms such as Arrowhawk Capital Partners, Sursum Capital Management and Goldman Sachs' Global Alpha each deciding to shut their doors.

Nevertheless, industry sources say institutional investors are likely to continue pouring money into hedge funds since positive returns are so difficult to achieve through other channels in the current environment. And though hedge fund performance sagged in 2011, they still posses the ability to generate non-correlated returns for pensions and endowments, which is a major selling point at a time when assets such as high-yield fixed income, commodities and even currencies have grown more correlated to an increasingly wild equities market.

"That lack of correlation is important because every pension fund works along the capital asset pricing model, which basically says lack of correlation is good even if the returns aren't always there," explains Nicholas Colas, the chief market strategist at ConvergEx, which provides technology to asset managers. The ability to hunt down opportunities for low correlation is going to be highly valuable this year, he adds, since "2012 is going to be like 2011 on steroids" due to the ongoing economic crisis in Europe.

"It's going to be more of the same but bigger," Colas says. "Hedge fund managers have quoted random volatility as a major reason why they're leaving the business. People think hedge funds are a path to easy money, but there's no more easy money left on the planet."

Glimmers of Hope

Yet there are glimmers of hope. Although data from Hedge Fund Research shows that the average hedge fund fell 4.45 percent in 2011 through Dec. 15, investors haven't been racing for the exits. Hedge fund administrator GlobeOp said investor redemptions for December were within the normal range for the end of the year. And Prequin projected that the industry's total assets will surge toward the pre-crisis total of $2.6 trillion on the strength of a large infusion of capital from institutional investors over the next 12 months.

"Overall, we're seeing that investor sentiment remains fairly high, and there's going to be a pretty significant influx on the institutional side," says Tim Calveley, an executive director at Butterfield Fulcrum, an administrator for alternative investment firms. "One of the drivers is: where else do people put their money? There's so much volatility everywhere and fixed income returns are close to zero -- even less than zero in a lot of respects."

As a result, the appetite for hedge funds among institutional investors is being driven largely out of necessity. Many pension funds are operating today with distribution rates that were set 10 to 15 years ago, when U.S. interest rates were much higher than they are today, according to Michael Tiedemann, the senior managing director at Tiedemann Wealth Management. But with interest rates so low, he explains, they're not reaping as much as they need to from their risk-free U.S treasury assets.

As the Senior Editor of Advanced Trading, Justin Grant plays a key role in steering the magazine's coverage of the latest issues affecting the buy-side trading community. Since joining Advanced Trading in 2010, Grant's news analysis has touched on everything from the latest ... View Full Bio

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