Investment Insight
AIP Hedge Fund Review and Outlook
 
 

Investment Insight

AIP Hedge Fund Review and Outlook

 

A Look Back at 2018

2018 was a difficult year for many asset classes, particularly during the fourth quarter. Commodities fell, global equities were down—by double-digits in some regions, and credit spreads generally widened throughout the year. Hedge funds were not immune from this market sell-off but did limit losses amid a broad market drawdown. Preliminary data indicates that hedge funds, as proxied by the HFRI Fund of Funds Composite Index, were down roughly 4% for the year.

Against this backdrop, we saw actively managed hedge fund portfolios on our platform outperform equities AND the broad hedge fund index. In some cases, they delivered positive absolute returns. Results varied and were driven by strategy allocation and manager selection decisions.

  • Strategy Allocation: From a strategy allocation perspective, at the platform level our constructive view on relative value fixed income, mortgage arbitrage, merger/risk arbitrage and macro contributed to performance. While our overall exposure to equity long/short detracted from performance, our conservative approach, shifting exposure from opportunistic managers to higher hedge managers as we went into the fourth quarter, mitigated losses suffered industry-wide. In our view, market and sector-specific exposures negatively impacted many long/short equity managers, but it was exposure to crowded stocks during deleveraging episodes that really impacted their overall returns. Sharp reversals in factor exposures also hurt.
  • Manager Selection: In terms of manager selection, our platform saw strong alpha returns from a subset of limited capacity managers as well as strong absolute returns from several global macro managers and a manager focused on trading distressed bonds in Puerto Rico.

As a business, we benefited from our new initiatives, including alternative lending and alternative risk premia, both of which were introduced in the fourth quarter and helped to preserve capital. Our co-investments program, another area of emphasis for us, was also a positive for the year.

2019 and Beyond

Looking ahead, we expect geopolitical and event-specific risks to remain at heightened levels for some time, and so we remain particularly constructive on the macro and relative value space. In our view, these strategies are poised to benefit from a higher volatility market regime that gives rise to more frequent and sizable market dislocations. We are also fairly sanguine on fixed income relative value because we expect a pickup in rate volatility to enhance the opportunity set for these managers.

Conclusion

As we’ve said before, we think the key to successful hedge fund investing today lies in an expanded view of what hedge funds can and should do. As investors, we seek to capitalize on our ability to invest across the liquidity spectrum and through an array of implementation options while maintaining a strict value-per-unit-of-fee discipline. For example, we emphasize negotiating bespoke structures that allow access to specific risk/return profiles, niche ideas and targeted high-conviction trades. Likewise, we seek to leverage our managed account platform and more liquid strategies, like risk premia, in order to take advantage at the other end of the liquidity spectrum in longer-term co-investment opportunities.

We believe the investing environment for hedge funds is fertile, and we remain very optimistic about what lies ahead.

 

1 Hedge Fund Research Inc., accessed on January 17, 2019

 

Index Descriptions
Hedge Fund Research, Inc. (HFRI) Fund of Funds Composite Index: The HFRI Fund of Funds Composite Index is an index of Fund of Funds, which invest with multiple managers through funds or managed accounts. The strategy designs a diversified portfolio of managers with the objective of significantly lowering the risk (volatility) of investing with an individual manager. The Fund of Funds manager has discretion in choosing which strategies to invest in for the portfolio. A manager may allocate funds to numerous managers within a single strategy, or with numerous managers in multiple strategies. The minimum investment in a Fund of Funds may be lower than an investment in an individual hedge fund or managed account. The investor has the advantage of diversification among managers and styles with significantly less capital than investing with separate managers. PLEASE NOTE: The HFRI Fund of Funds Index is not included in the HFRI Fund Weighted Composite Index.

patrick.reid
 
Managing Director
 
christopher.morser
 
Managing Director
 
 

IMPORTANT INFORMATION
The views expressed herein are those of the AIP Hedge Fund Team (the “Investment Team”) and are subject to change at any time due to changes in market and economic conditions. The views and opinions expressed herein are based on matters as they exist as of the date of preparation of this piece and not as of any future date, and will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date hereof. The data used has been obtained from sources generally believed to be reliable. No representation is made as to its accuracy.

Information regarding expected market returns and market outlooks is based on the research, analysis, and opinions of solely the Investment Team. These views do not represent views of other investment teams at Morgan Stanley Investment Management or those of Morgan Stanley as a whole. These conclusions are speculative in nature, may not come to pass, and are not intended to predict the future of any specific investment.

Certain information contained herein constitutes forward-looking statements, which can be identified by the use of forward-looking terminology such as “may,” “will,” “should,” “expect,” “anticipate,” “project,” “estimate,” “intend,” “continue” or “believe” or the negatives thereof or other variations thereon or other comparable terminology. Due to various risks and uncertainties, actual events or results may differ materially from those reflected or contemplated in such forward-looking statements. No representation or warranty is made as to future performance or such forward-looking statements.

Past performance is not indicative of nor does it guarantee comparable future results.

This piece is a general communication, which is not impartial, and has been prepared solely for informational purposes and is not an offer, or a solicitation of an offer, to buy or sell any security or instrument or to participate in any trading or other investment strategy. This communication is not a product of Morgan Stanley’s Research Department and should not be regarded as a research recommendation. The information contained herein has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

Persons considering an alternative investment should refer to the specific fund’s offering documentation, which will fully describe the specific risks and considerations associated with a specific alternative investment.

Alternative investments are speculative and include a high degree of risk. Investors could lose all, or a substantial amount of, their investment. Alternative investments are suitable only for long-term investors willing to forgo liquidity and put capital at risk for an indefinite period of time.

Alternative investments are typically highly illiquid—there is no secondary market for private funds, and there may be restrictions on redemptions or the assignment or other transfer of investments in private funds. Alternative investments often engage in leverage and other speculative practices that may increase volatility and risk of loss. Alternative investments typically have higher fees and expenses than other investment vehicles, and such fees and expenses will lower returns achieved by investors.

Funds of funds often have a higher fee structure than single manager funds as a result of the additional layer of fees. Alternative investment funds are often unregulated and are not subject to the same regulatory requirements as mutual funds, and are not required to provide periodic pricing or valuation information to investors. The investment strategies described in the preceding pages may not be suitable for your specific circumstances; accordingly, you should consult your own tax, legal or other advisors, at both the outset of any transaction and on an ongoing basis, to determine such suitability.

Morgan Stanley does not render tax advice on tax accounting matters to clients. This material was not intended or written to be used, and it cannot be used with any taxpayer, for the purpose of avoiding penalties which may be imposed on the taxpayer under U.S. federal tax laws. Federal and state tax laws are complex and constantly changing. Clients should always consult with a legal or tax advisor for information concerning their individual situation.

The information contained herein is proprietary and protected under copyright laws, and may not be reproduced or distributed. This communication is only intended for and will only be distributed to persons resident in jurisdictions where such distribution or availability would not be contrary to local laws or regulations.

Index data is provided for illustrative purposes only. Indices do not include any expenses, fees or sales charges, which would lower performance. Indices are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.

While the HFRI Indices are frequently used, they have limitations (some of which are typical of other widely used indices). These limitations include survivorship bias (the returns of the indices may not be representative of all the hedge funds in the universe because of the tendency of lower performing funds to leave the index); heterogeneity (not all hedge funds are alike or comparable to one another and the index may not accurately reflect the performance of a described style); and limited data (many hedge funds do not report to indices, and the index may omit funds, the inclusion of which might significantly affect the performance shown. The HFRI Indices are based on information self-reported by hedge fund managers that decide on their own, at any time, whether or not they want to provide, or continue to provide, information to HFR Asset Management, L.L.C. Results for funds that go out of business are included in the index until the date that they cease operations. Therefore, these indices may not be complete or accurate representations of the hedge fund universe, and may be biased in several ways.

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