Hedge Funds Facing Up to Tough 2023

Hedge funds are preparing for a tough 2023, with confidence falling to a two-year low in terms of the AIMA Hedge Fund Confidence Index (HFCI), which measures confidence levels funds have in the economic prospects for their business.

The Q4 survey provided responses from 328 hedge funds, accounting, AIMA says, for approximately $2 trillion in assets under management. The headline HFCI is +14.1, the lowest for two years, and the downturn in confidence is seen globally – the EMEA rating was +14.9, the UK +15.1, Asia-Pacific +13.8, and North American managers were the gloomiest at +13.5.

AIMA says the EMEA confidence score is influenced by Middle Eastern fund managers, who were the most confident of all the regional groups. Beyond the growth of several financial hubs across the Middle East as attractive domiciles for alternative investment funds, the score is driven by a respondent pool dominated by multi-billion-dollar global macro funds who are among the most confident demographics in terms of size and strategy, the survey finds.

Elsewhere, fund managers in the UK remain “stubbornly optimistic” as they were all year. UK respondents are twice as likely to be larger managers who are historically more confident than their smaller peers, the survey says. Similar to the Middle East, the UK respondent pool also includes a relatively large percentage of global macro funds. Moreover, the UK has fewer long-short equity funds – among the least confident strategies this quarter – compared to other regions.

APAC managers remained fairly consistent in their outlook throughout 2022 although the Q4 downturn only narrowly beat its lowest-ever score, recorded in Q4 2020. AIMA says the region had a slightly greater proportion of smaller managers and also a relatively high percentage of respondents representing the smallest cohort of managers, both of which served to depress the average confidence number.

As in the previous quarter, the drag on North America’s score can partly be attributed to a handful of digital assets fund managers, AIMA says, who posted record-low confidence. Additionally, it says that almost half of North American respondents were long-short equity managers, while a further one in five represented fund-of-funds which were even more gloomy, albeit less well represented in the overall demographic breakdown.

Although North America had a similar split as the UK between those managing greater than or less than $1 billion, it also had a relatively large pool of those managing up to $50 million who posted a lower-than-average confidence score across the AUM bands, it adds.

In a commentary on the survey, AIMA says the cause of the 10-point drop-off in the overall average confidence since Q3 2022 is “multifaceted” but will undoubtedly be partly due to the combined challenges of “the deluge of radical regulatory proposals from the US SEC and a chaotic macroeconomic landscape which shows no signs of settling as we begin the new year”.

It adds that rising interest rates, higher inflation levels, the very real threat of recession and broader market uncertainty underpin an increasingly downbeat economic outlook. This comes after a dismal year in which global equities have lost over 20% of their value while bonds have also tumbled. Subsequently, 60/40 portfolios (for a long time regarded as being the optimum investment strategy for pension plans and other institutional investors) posted one of its biggest annual negative returns, having nursed losses of close to 20%.

In the US, not a week seems to go by without another proposal being put forward by the SEC amidst the most serious overhaul of existing market practices for the private funds’ industry

“By comparison the average hedge fund is expected to end the year down between 4%-6% amid a mixed bag of performance with some hedge fund strategies (global macro, CTA/managed futures, and multi-strategy) delivering some very strong returns for their investors while others (long-short equity, long-only to name but two) enduring a very challenging year,” AIMA observes. “Capital outflows are coming under pressure throughout the past quarter across all asset classes including hedge funds.”

It says that confidence levels are further undermined by the increased set of regulatory headwinds that hedge funds must contend with. “In the US, not a week seems to go by without another proposal being put forward by the SEC amidst the most serious overhaul of existing market practices for the private funds’ industry,” it states. “Elsewhere work is ramping up across Europe, the UK and APAC as policymakers prepare to build on wave of new industry regulations that began in 2022 – all of which will impact how firms manage their business.

“That said, the terms of several of the most potentially damaging regulatory proposals, such as the SEC’s draft reforms to the Dealer Rule, are expected to be confirmed in the first half of the year and, regardless of the final terms, this will bring greater certainty to the market landscape,” it continues. “Moreover, some market signals indicate that inflation is due to peak, with some central banks indicating a lower ceiling to interest rates than might have been predicted in 2022. Greater clarity in these key areas may offer fund managers some reassurance in the ability to map out a future for their businesses even if other macro-headwinds persist.”

The index, which is collated by AIMA along with Simmons & Simmons and Seward & Kissel, is calculated during the last two weeks of each quarter. Respondents are asked to select the appropriate level of confidence on a scale of -50 (gloomiest) to +50 (the most optimistic). Factors they are asked to consider include their firm’s ability to raise capital, its ability to generate revenue and manage costs, and the overall performance of their fund(s).

“The past 12 months have been among the most challenging for businesses in many years,” says Tom Kehoe, global head of research and communications at AIMA. “Confidence levels among hedge funds are further curtailed by the gloomy prognosis for the global economy as well as additional industry headwinds in the shape of increased regulatory action. Reasons for hedge funds to be optimistic over the coming year include their ability to best manage risk amid the volatility being witnessed across global markets and an expectation of greater clarity around many of the regulatory proposals unveiled last year.”

Debbie Franzese, partner, investment management at Seward & Kissel, adds, “Given the current recessionary environment that we’re in and the headwinds that the economy and private fund industry is facing going into the new year, it’s unsurprising that North American-based hedge fund managers are the least confident they’ve been recently regarding the prospects of their business. The industry continues to experience increased regulatory focus from the SEC, this coupled with fundraising and performance challenges, increasing interest rates, inflation, and other macroeconomic considerations, can make for a perfect storm.”