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Our Capital Solutions team’s update on the global hedge fund industry outlook remains positive after improved returns seem to have boosted investor sentiment.

After recent years of headlines focused on perceived underperformance and investor dissatisfaction, the tide appears to be turning as the hedge fund industry evolves in response to these challenges.

Barclays’ Capital Solutions team first saw evidence of a rebound in early 2017, and a recent survey of over 265 hedge fund investors with ~$6.3 trillion in assets under management (AUM) suggests that sustained optimism is warranted. The results of the study indicate that, while lingering uncertainties still remain, investor sentiment continues to improve as the year continues.

Evolution of ‘Alpha’ in Post-Crisis Period

Source: HFR, Bloomberg, Capital Solutions analysis. Methodology: ‘Alpha’ is calculated on a monthly basis as 12-month rolling excess HF returns minus the ‘returns attributable to benchmark beta’ (e.g. Alpha as of 12/31/2011 is calculated as the average of excess HF returns from 1/31/2011 through 12/31/2011, minus returns attributable to benchmark beta’ during the same period). ‘Returns attributable to benchmark beta’ is calculated as the product of beta and the 12-month rolling excess benchmark returns. Beta is calculated using 36-month rolling returns data for each HF strategy and their respective benchmarks (S&P 500 TR Index for Equity Hedge and Event Driven; Barclays Global Aggregate Index for Macro and Relative Value).

In the first half of 2017, AUM grew 7% year-over-year (YoY) driven entirely by performance, as net flows were negative over this period. The second quarter brought a turning point as asset flows turned positive following six consecutive quarters of net outflows. Alpha—the portion of a fund’s returns not attributed to broader market movements—also improved significantly for the first half of 2017. Specifically, equity and event-driven strategies generated the highest levels of alpha observed since the crisis.

In terms of investor sentiment, our study suggests that investors are more satisfied than they have been in some time. Returns were better than expected across strategies in the first half of 2017, although it is possible that investors have simply set their targets lower after a period of muted hedge fund performance. By channel, family offices and private banks appear to have seen the most outperformance as measured by returns exceeding targets by greater than 1%, followed by public pensions.

Planned Allocation Activity to Hedge Funds

(1) Excludes Intermediaries; (2) YE projections are for the upcoming year, 1H17 plans are for the next 6 months

Source: All figures refer to Barclays' Capital Solutions team survey results only

The positive sentiment from recent returns appears to be reflected in investors’ allocation plans for the near term.  Approximately 65% of investors plan to increase their hedge fund allocation, up from 48% at the end of 2016. Meanwhile, the percentage of investors planning to reduce their hedge fund exposure has decreased to its lowest level of the period. Sentiment is now twice as positive as it has been in almost two years, suggesting that hedge funds may experience more robust inflows in the near future.

Investors indicated that the primary reason behind their decision to increase hedge fund allocations is anticipated positive performance. However, when looking at investors planning to decrease allocations, performance was the least cited reason except in credit strategies (e.g. credit long/short, distressed credit), which suggests that investors are more sensitive to anticipated outperformance than underperformance.The top reason cited for plans to decrease hedge fund allocations was concern about specific managers across strategies, also except in credit.

Hedge Fund Strategy Preferences (I/II) – Plans to Increase/Decrease

Note: The net difference is a proxy for investor interest: % of respondents who plan to increase minus % who plan to decrease allocations

Source: All figures refer to Barclays Capital Solutions team's survey results only

The strategies most in favor among investors appear to be quant equity, event-driven equity, market neutral/low net equity, and fixed income relative value. Distressed credit and multi-strategy are the hedge fund strategies least in favor, in part due to anticipated underperformance in the case of the former, and manager-specific concerns and portfolio rebalancing in the case of the latter.

In general, sentiment among hedge fund investors remains positive, but investors are still concentrated and cautious as uncertainties remain heading into 2018.

Contact the Capital Solutions team

If you are interested in the full study Running with the bulls (available to clients of Barclays Investment Bank), or if you would like to learn more about our Capital Solutions team's services and reports, please contact strategicconsulting@barclays.com.

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