23 June 2013

Hedgeweek: Are US hedge funds more attractive? A tale of two markets

Defining the market with a view to analysing competition provides those from the European side of the pond eager to make their mark in the hedge fund industry with a striking starting point: this is a global industry in which the top performers worldwide are managed from the US.

While the top performing hedge funds are managed from the US, a closer look reveals an uneven split among investment strategies: equity long/short and distressed debt seem to pertain firmly to the US; however, factors relating to size, history, risk appetite and market access may also explain – as well as nuance – the results.

On the revenue side of the equation, the change in the investors’ landscape has had an impact on due diligence and on investor’s need for liquidity. On that front also the regional split can be observed. Diverging regulatory frameworks on either sides of the Atlantic will be imposing costs which are likely to accentuate differences rather than bridge a gap. Ultimately, the findings may provide some indication on how the industry is being shaped, with long-term strategic impact.

When asked what they go to the US for, European investors’ typical answer includes equity long/short as a strategy of choice. Some also wonder whether distressed debt might be the next highly performing strategy, and if so, would be more comfortable accessing it in the US, due, in part, to better established bankruptcy laws.

The liquidity of the investments made by the funds and the sophistication of the US market may be a reason for the over-performance by US managers. Volumes traded are larger, markets are more efficient, the resulting information being reflected in the price of the investments faster than elsewhere. Due to their sizes, US funds are more able to invest worldwide than their counterparts; however, they would typically invest in US-listed stocks first, which are covered by more research analysts around the globe than non-US stocks. Shorting stocks in other parts of the world sometimes proves more difficult (e.g. in Asia), and this ease of trading, within one jurisdiction and under one regulatory umbrella, also contributes to the fact that, currently, 40 per cent of hedge fund investments are targeted at the Americas, 10 per cent at Europe and Asia, and 45 per cent at global funds.

With access to capital easier in the US than in Europe or elsewhere, it is possible that US hedge funds have not needed to adjust to demand elsewhere, be it via the adoption of the UCITS model or otherwise. Thus, it appears that US hedge funds may not be substitutes to their European counterparts after all, since they address different consumer needs in different markets.

European hedge funds’ increasing liquidity over the past few years has been the only way to compete for local investors. While they have been able to differentiate themselves to keep the European segment of the market, that strategic move does not seem to have forced US hedge funds to do the same. This would tend to argue in favour of the existence of two distinct markets: one in which liquidity is a necessary condition and the other one where investors are agnostic to this factor. If this is true, the advantage US hedge funds have would, in part at least, stem from a combination of better availability of capital and relative indifference to liquidity, two luxuries their European counterparts do not benefit from.

From the above it appears that US hedge funds are, from many respects, different from their counterparts from elsewhere in the world. While the mobility of capital would tend to argue in favour of a single market for hedge funds worldwide, the increasingly regional regulatory framework, as well as investors’ preferences, shows an enhanced degree of fragmentation for now and for a few years to come. Understanding those differences and incorporating them in strategic planning is a worthwhile exercise for emerging and established managers alike.

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