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Event driven paper finds investors disenchanted

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A new study from Barclays Prime Services examines the effect of poor performance in the event driven hedge fund strategy on institutional investor demand and reveals that, in recent years, those strategies have been some of the most consistently in demand among investors.

“The continued hangover of the 2008 financial crisis, combined with a buildup of cash on corporate balance sheets and cheaply available financing, created a seemingly rich opportunity set for event driven managers to capitalise upon,” the firm writes. Investors flocked to event driven hedge funds, investing record amounts over the three year period from third quarter 2012 to third quarter 2015.
 
However, from the second half of 2015 onwards, performance across the board in hedge funds was challenging, while event driven managers have suffered the worse. The disconnect between their popularity and their performance encouraged Barclays to examine what was going on.
 
“We wanted to understand whether, on the basis of long-term performance, stand-alone event driven hedge funds merit a place in investors’ portfolios – and if so, what is behind the recent underperformance: was this a blip or a sign of structural challenges faced by event driven hedge funds? Lastly, in light of recent developments, we wanted to see if investors are still enthused about event driven hedge funds – and what event driven managers should prepare themselves for in terms of asset raising in 2016.”
 
Barclays define event driven hedge fund strategies as comprising five underlying sub-strategies, all focused on capitalising on opportunities in corporate events: merger arbitrage, special situations, distressed, activist and multi-strategy event driven (a combination of more than one event driven strategy sleeve).
 
The firm finds that event driven has been the fastest growing strategy in the hedge fund industry since 2000, with a CAGR of 17 per cent; it now represents over a quarter of total industry assets. Within event driven, hedge funds, activist and multi-strategy event have been the fastest growing sub-strategies.
 
The strategy has also been one of the best performing strategies on a risk-adjusted and absolute basis over the last ten years, the firm finds, outperforming equity L / S and the broader industry.
 
However, this gap has narrowed of late. “Based on our estimates, event driven hedge funds have generated an average of 5 per cent per annum of annualised ‘alpha’ net of their market exposure – a significant outperformance when compared to equity L / S hedge funds; they also have a differentiated distribution of returns versus the broader industry.
 
“Geographically, event driven hedge funds appear to have a preference to focus on specific geographical regions (versus investing globally), and in particular have a strong skew toward the US, geographically. US-focused hedge funds have underperformed their peers over the past 18 months, possibly reflecting ‘crowding’ challenges.” 
 
The data reveals that on average, event driven hedge funds are much larger than the average hedge fund at more than twice as large. The study shows that this is driven in particular by the size of special sits and activist hedge funds. Recently, the largest event driven hedge funds also appear to have underperformed their smaller peers. The best risk adjusted returns have come from merger arbitrage and multi-strategy event  over the last ten years, while distressed and special sits hedge funds have lagged the overall strategy average.
 
The return profiles merger arbitrage and multi-strategy event hedge funds deliver were also found to be significantly different. The firm finds that merger arbitrage has the lowest absolute returns but these have been generated in a much steadier fashion versus activist and special sits, which tend to have much larger drawdowns in difficult markets.
 
“However, on an individual hedge fund level, it is merger arbitrage and distressed hedge funds which historically have been most prone to delivering ‘3 sigma’ down months,” the report says. “The level of correlation between hedge funds within each sub-strategy is lower for event driven broadly than for traditional equity and credit L / S Hedge funds; merger arbitrage and distressed hedge funds have the lowest level of intra-strategy correlation, suggesting these hedge funds capture idiosyncratic risks well.”
 
Performance since the second half of 2015 has been challenged, particularly for activist, special sits and distressed hedge funds. The report writes that it appears that much of this may have been driven by problems of crowding in US special situations names, losses in energy, and the turning of the credit cycle in distressed.
 
The majority (two-thirds) of investors Barclays Prime Services surveyed felt that performance of their event driven hedge funds has been below expectations over the last 12 months.
 
“Investors tended to primarily hold crowding and energy exposures responsible for performance challenges in their event driven portfolios; a bias toward value stocks and the impact of new regulations on M&A, as well as broader macro issues, shouldered the blame.
 
“In light of recent issues, investors are now particularly focused on identifying event driven managers that are able to identify unique ideas, have long tenure in markets and a solid pedigree, and that have demonstrated strong risk management..”
 
The findings are that only one-quarter of investors Barclays surveyed plan to increase their event driven exposure over 2016, with most looking to keep their allocations unchanged and about 15 per cent looking to reduce their exposure.
 
The paper concludes: “Within sub-strategies, we expect distressed and merger arbitrage hedge funds to benefit from net inflows, while special situations and multi-strategy event hedge funds will likely see small outflows, and activist hedge funds should expect to have to deal with significant net outflows in the coming months. We believe that there will still be significant (~USD65 billion) money in play for event driven managers as a result of reallocations and new inflows, although event driven as a whole will likely see net outflows (~USD10 billion).

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