Hold onto your hats! From AI to cryptocurrencies – rapid change is the only constant for hedge funds. Digiterre’s top 10 hedge fund trends for 2018.
What’s the outlook for the hedge fund industry over the year ahead? The industry will continue to evolve and at breakneck speed. Digiterre, a leading provider of workflow and relationship management software systems to the investment management sector, summarise the top ten trends for hedge funds over the months ahead:
1) Political volatility in markets will present major opportunities for hedge fund investments
Brexit and the US mid-term elections will be just two of the upcoming events favouring global hedge fund volumes and activity, contributing to the overall growth rate of 5.5% in 2018 forecast by Agecroft Partners. 2018 is very likely to see a continuation of the hedge fund growth witnessed in 2017 and be a year of macro investing. An estimated $1trn of debt maturing in Europe, the Middle East and Africa will boost the estimated $5trn in dry powder (cash and liquid assets) available as investors seek alternatives to more passive, low-cost investment strategies. These alternatives will include hedge funds, likely to play a more central role in private wealth and institutional portfolios.
2) Asia and developing markets will be increasingly attractive for investment
Another extension, even acceleration of 2017 hedge fund activity, will be greater exposure to Asian and developing markets. And especially to the giant economies of China and India – both driving for greater openness to the rest of the world and further reductions in their previously stifling bureaucracies. Hedge funds such as Pharo, Bluecrest and Adar have recently proved the returns possible from emerging markets in stark contrast to some players more exposed to developed markets. Asian markets also typically offer lower P/E multiples, higher volatility and less institutional ownership – all signs traditionally good for hedge fund investment.
3) Cryptocurrencies will be a must for diversified portfolios
The digital coin sector is bound to increase and play a growing part of diverse, rather than single investment strategies. Whilst it’s still very early days, we think it will continue to experience huge innovation, evolution and exponential growth and will ultimately end up as a commonly used consumer currency. The Cboe options exchange has already announced the commencement of bitcoin futures trading and there are already over 120 hedge funds focused on the area. Commentators like Agecroft expect the number of hedge funds involved in cryptocurrencies to at least double or treble in 2018 alone. Whilst future growth is forecast in the overall industry, at the same time you can’t ignore the significant caution advised over bitcoin, its largest player, who many see as having been bid up by excessive hype and speculation into potentially one of the largest financial bubbles in history!
4) Not only bitcoin, but blockchain technology will roar ahead too
The strong overall hedge fund market performance for 2017 was dwarfed by returns from the HFR Blockchain and HFR Cryptocurrency indexes that track managers investing in bitcoin, ethereum and others in the cryptocurrency space, as well as companies involved in blockchain technologies. In 2018, technical pioneers will continue to build a future where humans play only a minor role in setting up, regulating and reporting the regulatory requirements of investment funds; everything will be underpinned by cutting-edge technologies. Innovations are emerging across the whole investment management chain to bring data securely to the blockchain (e.g. by Oraclize), exchange assets in a secure peer-to-peer way (e.g. with exchanges like Ox, Kyber, Oasisdex), issue digital assets on chain (e.g. such as regulated equities and derivatives) and setup and regulate investment funds.
5) Reinsurance stocks will become increasingly attractive for hedge fund investment
2018 is likely to see further hedge fund investment growth in reinsurance stocks due to expected price increases, driven by the hurricanes of 2017. Furthermore, the earthquakes in Mexico and wildfires in California mean that 2017 could even be the worst year on record for insurance losses. Munich Re and Swiss Re, the world’s biggest reinsurers, have said they expect reinsurance rates to rise in consequence, with Swiss Re seeing rates rising by up to 50 percent in disaster-hit areas. Several hedge fund goliaths are betting on a significant recovery for reinsurance stocks including Marshall Wace, Marathon Asset Management and Balyasny Asset Management.
6) Long/short equity managers will seek to add significant value through IT advantages
Managers will continue to investigate and implement a plethora of new technologies to add value and enhance hedge fund investment processes, client management and decision making. This includes technologies such as quantitative analytics, alternative data sources, cutting-edge CRM platforms, machine learning and artificial intelligence. Information breakthroughs and new technologies will be increasingly used to increase efficiency and accuracy in sourcing information, researching ideas and executing investments.
7) Hedge fund service outsourcing will continue its upward spiral
Coupled with the growth in use of more sophisticated technologies by hedge funds in the drive for better quality, will be the outsourcing of several parts of hedge fund business infrastructure. This is also likely to include parts of hedge fund research and investment related activities. These may include IT, legal, compliance, 3rd party marketing, back office, data providers and analytics. In parallel to and in response to these outsourcing shifts, firms will place even more focus on cyber security and disaster recovery policies and procedures.
8) Growth of hedge fund distribution will occur from global marketing innovation
Several specialist law and marketing firms have developed products that can identify and simplify the requirements to market investment funds in over 100 countries around the world. Many of these countries now have lower barriers to entry or benefits that are high enough to justify the various on-costs and requirements necessary to gain a marketing presence. A significant number of investors in these jurisdictions will be looking for high quality hedge fund managers but to date, have been underserved. These products can finally provide a breakthrough to marketing in these jurisdictions.
9) The squeeze on hedge funds will lead to some culling of numbers
The squeeze from both the expense and revenue sides of hedge fund businesses, especially for the majority with less than $100m in assets, will lead to some closures where funds are underperforming.
Furthermore, downward fee pressure will continue on any size of hedge fund struggling with underperformance; this will be coupled by growing competition from alternative, similar investment management products which also have lower fees. These will include smart beta products, alternative uses products and rich premium products.
10) Less traditional fee structures will emerge in 2018
Finally, less traditional fee structures are likely to become a regular part of new fund allocations. With hurdles (before any performance fees are charged) for any investors who have the leverage to negotiate. We agree that the investor community is correct in demanding that alpha alone should merit performance fees.
And these are only our top 10 trends, by no means all of the trends likely to visit the hedge fund industry in 2018. Hold onto your hats? Fasten your seatbelts too!
(Source: Bloomberg News, Agecroft, Mercury, CNBC, Coindesk, Reuters).