Introduction
VanthedgePoint Group, Inc, an integrated financial services and technology firm catering to small hedge funds, conducted its second annual Emerging Hedge Fund Manager Sentiment Survey in January 2007. The survey was sent electronically to over 1,270 hedge fund managers. The email list was compiled through a number of proprietary sources, and included potential and existing clients. The survey consisted of 15 multiple choice questions and the company received a total of 189 responses.
The purpose of the survey was to gauge the outlook of emerging hedge fund managers on a number of economic issues and the performance of financial markets for 2007. VanthedgePoint prepared this survey because there is a general lack of research regarding this segment of the hedge fund market due to its highly fragmented state. However, there is a number of talented managers within this segment that in the aggregate manage nearly US$100 billion in assets, which makes knowing their opinions important, particularly in light of the results of the 2006 survey, which demonstrated these managers’ ability to accurately assess the financial landscape and invest successfully in 2006.
What follows are the survey’s questions and the corresponding responses received along with a brief analysis.
Data Analysis
1. Are you bullish, bearish or neutral on the US economy in 2007?
A majority of respondents indicated that they were “neutral” (57.4%) on the prospects for the US economy in 2007, but bulls outnumbered bears by nearly three-to-one. We suspect that the neutral stance adopted by emerging hedge fund managers stems from their concerns about continued weakness on the real estate front, and their fears of rising inflation.
2. What macro factor do you think will play the most important role in how the US economy fares in 2007?
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Energy costs were also seen to play a much less influential role this year compared to the 2006 survey when 39% of respondents thought “rising energy costs” would play the most important role in how the US economy performed. However, worries of a continued “real estate market slowdown” still ranked highly in the 2007 survey. Emerging hedge fund managers felt that the “change of control in US Congress” is not going to play an important factor in how the US economy fares in 2007.
3. Are you bullish, bearish or neutral on the US stock market for 2007?
On the US stock market, emerging hedge fund managers were slightly more opinionated with only 44.3% taking a neutral stance. Given the strong performance of US equity markets in 2006, it is understandable that respondents may be less bullish than last year, when 46% of respondents held bullish sentiment. About the same percentage hold bearish views in 2007 (18%) as did in 2006 (20%).
4. Which sectors do you expect to be among the BEST performers in the stock market for 2007? (Please select all that apply)
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5. Which sectors do you expect to be among the WORST performers in the stock market for 2007? (Please select all that apply)
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Technology (41%) and Financial Services (31.2%) are expected to perform the best in 2007, while Automotive (32.8%) and Real Estate (27.9%) are thought to be the worst sectors to invest in for 2007. Interestingly, respondents also felt that Technology (24.6%) would also be among the worst-performing industries this year. Emerging hedge fund manager opinions on Raw Materials, the most favoured sector last year (51.2%), fell significantly as it appears they believe the run-up in energy and raw materials prices has largely run its course. We believe the opinions regarding best and worst performing sectors played an important role in survey respondents’ outlook for international markets.
6. Among US equities, which capitalisation stocks do you expect to perform the BEST in 2007?
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But among US equities, respondents were almost evenly split when identifying which market capitalisation will perform the best in 2007. 36.7% believe large-cap stocks will lead the stock market while 33.3% favour small-cap stocks. Given that in 2006 the Russell 2000 outperformed the Dow Jones Industrial Average, S&P 500 and NASDAQ Composite, a stance favouring a rotation into larger cap stocks is reasonable.
7. Which of the following international markets do you think will perform the BEST in 2007? (Please select all that apply.)
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8. Which of the following international markets do you think will perform the WORST in 2007? (Please select all that apply.)
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Once again, China (34.4%) is predicted to be the best place to invest in for 2007, but Japan (34.4%) has also been picked to outperform other international markets. Latin America (37.7%) replaces Western Europe as the worst place to invest in for 2007, along with Russia (23.0%). Instead, Western Europe (21.3%) joins Eastern Europe (23.0%) and India (21.3%) as being predicted to be one of the best international markets for 2007.
The attitude change related to Latin America and Russia likely stems from emerging hedge fund managers’ belief that both raw materials and energy will underperform other asset classes in 2007. In 2006, raw materials and energy posted strong returns, and both are considered to be key industries that helped propel emerging markets like Latin America and Russia in 2006. Given their strong performance last year, it appears our survey respondents believe that their expectations for declining prices for raw materials and energy would cause the Latin American and the Russian markets to cool off, and therefore, make them less attractive places to invest for 2007.
9. Which asset class do you expect to be the BEST performing in 2007?
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Emerging hedge fund managers anticipate that US Equities (44.3%) will be the best performing asset class in 2007. Last year’s survey respondents accurately predicted that International Equities and Commodities would perform best in 2006 (US equities ranked third).
10. Which asset class do you expect to be the WORST performing in 2007?
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Commodities fell out of favour to be ranked as one of the worst performing asset classes, while International Equities ranked as the second best asset class in which to invest in for 2007. Real Estate (27.9%) and High Yield Debt (24.6%) are both expected to be the worst performing asset classes in the coming year.
11. Do you currently hold any index-based products in your portfolio?
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Use of index-based products, such as exchange-traded funds, among emerging hedge fund managers nearly doubled to 62.3% in 2007 from 43.9% in 2006, demonstrating their growing popularity as a low cost hedging tool. This is understandable given the size of assets managed by survey respondents: over half (50.8%) manage less than US$10 million and over 85% manage less than US$100 million.
12. What is the size of your hedge fund (in USD)?
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The size distribution of survey respondents is consistent with industry (Strategic Financial Solutions Database Study 2004) and academic research on the hedge fund marketplace. Most published studies estimate that 80% of all hedge funds manager manage less than US$100 million, while approximately 50% manage less than US$25 million.
13. Where are you located?
Almost all survey respondents are based in the US, which is likely biased due to our US focus and only recently-introduced international service capabilities.
14. Does your hedge fund have an onshore vehicle, offshore vehicle or both?
Over two-thirds of respondents only offer onshore vehicles for their hedge funds, while 27.4% offer investors onshore and offshore options.
15. Do you accept investments through separate accounts?
55.7% of emerging hedge fund managers accept investments through separate accounts and 32.8% would consider doing so. This is strong evidence in support of the difficulty emerging managers face when trying to raise assets, which was a key finding of this year’s survey. Separate accounts (also known as separately managed accounts) have grown in popularity among hedge fund investors because they provide investors with greater visibility and control over their assets.
16. What do you think is the single most difficult aspect of running a hedge fund business?
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70.0% of all respondents indicated “raising money/marketing” is the single most difficult aspect of running a hedge fund business. This is logical given that most emerging hedge funds are small businesses operated by one or two individuals who typically are former portfolio managers, traders or research analysts. These individuals know how to manage money and trade for profit, not how to market a hedge fund to investors.
In addition, if these individuals divert significant time towards marketing activities it is reasonable to assume that their investment performance may suffer, which could have lasting, devastating effects on an emerging hedge fund. Marketing becomes more difficult for an emerging hedge fund that fails to deliver superior returns, an in many cases leads to the fund’s eventual closure.
Separately, a surprising result was that 20.0% of respondents thought “finding investment opportunities” was the most difficult aspect of running a hedge fund business.
Conclusion
Numerous studies show that smaller, younger funds tend to outperform larger funds, which lends credibility to the opinions gathered through this year’s survey. The views represented may not be from well known hedge fund industry titans, but many of today’s hedge fund elite started small and grew, thanks to their ability to deliver consistent, exceptional performance. In fact, VanthedgePoint recently announced that its clients averaged an annual return of 16.74% in 2006, outperforming not only the major hedge fund indices, but also the major US stock market indices. Therefore, emerging hedge fund managers should not be overlooked when gathering sentiment about the global investment climate.
This document was prepared to provide a summary and analysis of the VanthedgePoint Emerging Hedge Fund Manager Sentiment Survey. Neither VanthedgePoint nor any of its employees, makes any warranty, expressed or implied, or assumes any legal liability or responsibility for the accuracy, completeness, or usefulness of any information, product, or process disclosed, or represents that its use would not infringe privately owned rights. The opinions of the authors expressed herein are for informational and discussion purposes only.
