A tale of two years for hedgies

In the first of a two-part Q&A, Karen Tan of Deutsche Bank Private Wealth Management looks at hedge-fund performance since the start of 2008. In the next piece, she will make some forecasts.

Hedge funds posted their best performance for a decade in 2009, chalking up a particularly stellar performance in the last quarter. Karen Tan, a director in the hedge fund group at Deutsche Bank Private Wealth Management in Singapore, shares her views on the industry and on the performance of this asset class in 2008 and 2009.

Tan leads the due-diligence efforts on Asia-based managers and Asia-focused mandates in the traditional and alternatives space. She joined Deutsche Bank in April 2007 and before that worked for Citi Private Bank Singapore, most recently as head of product management for the advisory range of managed products.

Can you give us your general overview of hedge funds and their performance as an asset class over the past few years?
Hedge funds have historically been synonymous with high returns and high risks, with many of them shrouded in mystery in terms of how they generated their stellar returns. Prior to 2008, one could not be faulted for such a perception. If we look at the phase from 1990 to 2007, hedge-fund performance was 9.74% a year.

However, we hope 2008 will go down in the industry's history as the single worst year for the hedge fund industry on record, as the industry posted a 19% loss for the year (according to the HFRI Fund-Weighted Composite US Dollar Index). Last year was a return to normalcy, with hedge funds producing 20% returns.

Industry players say 2008 is purportedly the worst performance year for hedge funds on record. Could you talk us through the main developments and how different strategies fared?
The historic and unprecedented developments in 2008 -- the Lehman bankruptcy, liquidity and subprime crisis, financial-sector bailout, forced liquidations due to margin calls (all events largely beyond the control of the hedge fund managers) and the Madoff fraud -- all compounded and impacted the industry significantly. This was further illustrated by the fact that losses for 2008 were largely concentrated in the three months following the Lehman failure, with the HFRI composite index showing a loss of 14.9% in the three months from September to November 2008.

Throughout the year, virtually all parts of the hedge-fund business were put to a test, including counterparty risk management, operational structure, liquidity management and handling of investor redemptions. On top of this, 2008 was characterised by broad-based government intervention, with the short-selling ban and rescues of certain financial institutions being the most prominent examples.

However, some strategies performed much better than others. CTAs/managed futures generally posted strong gains in 2008, defensive long/short equity funds did a good job in preserving capital and merger-arbitrage strategies benefited from low leverage and a clear focus on strategic deals.

Indiscriminate selling and fear by investors -- mostly non-institutional -- led to massive redemption pressures, exacerbating a vicious downward cycle. By the end of 2008, the industry's assets under management had fallen below that for December 2006 of $1.5 trillion, as a result of massive outflows and poor performance.

According to estimates by Eurekahedge, total net redemptions for 2008 amounted to circa $198 billion. This contrasted sharply with a net inflow of $195 billion in 2007.


Tremendous redemption pressures resulted in an unprecedented move by many funds to suspend redemption payouts simultaneously, creating side-pockets or delaying payments of liquidation proceeds. According to the Credit Suisse Tremont Index (CSTI), about 11.6% of the $1.5 trillion industry became 'restricted' at the end of 2008.

With the recovery taking hold in 2009, hedge funds chalked up their best performance for a decade. What is your take on this?
2009 did not start like an easy investment year, but in the end it was certainly an extremely good one for risky assets. The rebound was especially strong in high-beta investments, whether in equities (the MSCI Emerging Markets gained 78.5% over the year) or credit (Bank of America Merrill Lynch US High Yield Master II was up 57.5%).

The best hedges in 2008 -- US government bonds in the traditional investment world and CTAs in the hedge-fund world -- ended the year in negative territory. The average hedge fund had its best year in a decade (the HFRI Composite US Dollar Index gained 20.0%).

It is worth noting that, for hedge funds, 2009 was more a dynamic than static beta year. At the start of the year, industry averages barely moved during the hefty stock market sell-off that lasted until March 9. But as the risky-asset rally gained momentum, economic data improved and market volatility fell, the hedge fund industry put on more risk, albeit in a very gradual manner. The increased beta to the stock market helped most parts of the industry to recover losses incurred in 2008.

The strategies that suffered the most in 2008 -- emerging-markets and convertible-arbitrage -- posted a strong recovery last year, gaining 34.78% and 43.69%, respectively. Meanwhile, CTAs, the strongest performers in 2008, were the biggest laggards in 2009.

What has this meant for hedge-fund investors?
As the markets have improved, there have also been improvements in the liquidity of hedge funds, with suspensions being lifted and several redemptions being paid out, leaving about 5.5% of the $1.4 trillion still restricted by the end of 2009, according to the Credit Suisse Tremont Index.

Over the course of 2009, there has also been renewed interest from institutions in allocating to absolute-return strategies again. While inflows have been slow, certain pockets -- such as pension funds -- that often use hedge funds as an equity substitute have contributed.

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