Research

Eurekahedge European Investor Perspectives – Zurich 2019

Altinvestor Europe 2019 is Eurekahedge’s third European asset owner forum and the seventh of its kind across Europe and APAC regions, delivering exclusive insights from family offices as well as institutional asset owners on exploring alternative investments and optimizing portfolio returns. The event is aimed at facilitating a private environment for candid discussions between investors and to serve as a melting pot of ideas connecting Europe’s leading institutional investors under one roof.

Machines and humans: The implementation of deep learning in asset management

The first day of Altinvestor Europe 2019 started with presentations from pension portfolio managers on the implementation of machine learning technologies in asset management, and how they complement human expertise. The recent improvement in computer processing power and advancement in algorithms, combined with the increase in data availability have acted as tailwinds for the adoption of machine learning in various fields, from marketing, image recognition, language processing and financial services. Deep learning techniques could be adopted in various stages of the investment process, from analysis, decision making, to continuous process improvement based on feedback. On the other hand, the black box nature of certain machine learning-based hedge fund strategies proved to be a challenge for fund managers to market their funds to investors. Nevertheless, both investor demand and technology adoption within the hedge fund industry have grown rapidly over the recent years.

Figure 1 below illustrates the performance of the Eurekahedge AI Hedge Fund Index, an equal-weighted index representing 52 unique hedge funds utilising AI/machine learning-based strategies. These hedge funds have returned 12.75% per annum since the end of 2009, as opposed to the 4.95% annualised return recorded by the Eurekahedge Hedge Fund Index over the same period.

Figure 1: Eurekahedge AI Hedge Fund Index performance since 2009
Eurekahedge AI Hedge Fund Index performance since 2009

Table 1 compares the risk-return statistics of the Eurekahedge AI Hedge Fund Index and the Eurekahedge Hedge Fund Index over the past decade. It could be observed that despite their outperformance over the longer period, AI hedge fund managers have struggled to generate returns over their peers utilising other hedge fund strategies.

Figure 1: Eurekahedge AI Hedge Fund Index performance

                                                                                               

Eurekahedge AI Hedge Fund Index

Eurekahedge Hedge Fund Index

2010

54.17%

11.56%

2011

16.61%

(1.67%)

2012

1.96%

7.40%

2013

14.13%

9.12%

2014

10.57%

5.18%

2015

17.90%

2.36%

2016

10.16%

4.78%

2017

8.41%

8.59%

2018

(4.31%)

(3.93%)

October 2019 year-to-date

4.41%

6.27%

3-year annualised return

2.55%

3.90%

3-year annualised volatility

4.20%

3.30%

3-year Sharpe ratio (RFR = 2%)

0.13

0.57

5-year annualised return

7.62%

3.75%

5-year annualised volatility

4.45%

3.29%

5-year Sharpe ratio (RFR = 2%)

1.26

0.53

Source: Eurekahedge

Success in ESG engagement

A representative from an Australia-based superannuation fund provided insights on how ESG frameworks could improve a fund’s value proposition toward its investors. Risk assessment and identification of value drivers are some of the key parts of implementing an ESG framework in asset management. Direct investment is considered as the best way to achieve ESG implementation, as it allows fund managers to exert influence on the underlying portfolio companies through active engagement, votes and class actions. Institutional investment firms also have the option to join organisations such as IIGCC or PRI to collaborate with other firms in effecting changes. Direct investment and engagement also grant investors better ability to assess the portfolio company’s ESG risks without relying on third-party ratings.

Figure 2 illustrates the performance of the Eurekahedge ESG Fund Index, an equal-weighted index representing 97 unique hedge funds adopting ESG frameworks in the construction of their portfolios. These ESG funds have generated an annualised return of 3.52% since end-2007, outperforming the benchmark MSCI ACWI ESG Leaders which returned 3.00% annually over the same period.

Figure 2: Eurekahedge ESG Fund Index performance since 2007
Eurekahedge ESG Fund Index performance since 2007

The table below provides the yearly returns of the Eurekahedge ESG Fund Index, the Eurekahedge Islamic Fund Index, as well as the MSCI ACWI ESG Leaders, which represents companies with high ESG ratings. Despite falling behind their benchmarks, ESG fund managers have successfully generated better risk-adjusted performance, as represented by their Sharpe ratios over the last three and five years.

Table 2: Eurekahedge ESG Fund Index performance

Eurekahedge ESG Fund Index

Eurekahedge Islamic Fund Index

MSCI ACWI ESG Leaders

2008

(33.57%)

(28.60%)

(41.55%)

2009

33.67%

21.87%

31.97%

2010

13.61%

9.63%

10.43%

2011

(9.54%)

(3.31%)

(8.41%)

2012

10.28%

7.86%

12.42%

2013

13.06%

9.92%

21.91%

2014

4.02%

2.95%

2.80%

2015

3.50%

(1.81%)

(4.15%)

2016

9.48%

4.23%

5.54%

2017

12.60%

6.92%

20.67%

2018

(6.03%)

(4.66%)

(10.43%)

October 2019 year-to-date

6.15%

7.62%

18.00%

3-year annualised return

4.62%

3.95%

9.29%

3-year annualised volatility

3.80%

4.43%

11.04%

3-year Sharpe ratio (RFR = 2%)

0.69

0.44

0.66

5-year annualised return

4.65%

1.79%

5.13%

5-year annualised volatility

4.53%

5.27%

11.43%

5-year Sharpe ratio (RFR = 2%)

0.59

(0.04)

0.27

Source: Eurekahedge

Roundtable discussion: ILS market correction?

The insurance-linked-securities (ILS) market has seen robust growth in the recent years, with just under US$90 billion in alternative ILS capital by the third quarter of 2019. The increase in competition among reinsurers, product innovation, and declining fees as a result of improving efficiency have contributed to the expansion of the sector. The recent Atlantic hurricane seasons of 2017 and 2018 have triggered a correction in the ILS market, resulting in substantial losses for ILS funds. The industry is still extremely skewed toward US catastrophes, which have continued to be the key driver of risk, along with higher returns, at least until the increasing capital inflows began to suppress premiums and margins in recent years. Some ILS fund managers have also commented that population growth and increase in population density are major concerns which may carry greater risks than climate change for ILS investors.

The figure below compares the performance of the Eurekahedge ILS Advisors Index against comparable benchmarks. ILS hedge funds have generated returns that are generally uncorrelated to other financial instruments, thereby providing diversification benefits for investors. The Eurekahedge ILS Advisers Index has returned 3.37% per annum since the end of 2007.

Figure 3: Eurekahedge ILS Advisers Index performance since 2007
Eurekahedge ILS Advisers Index performance since 2007

Table 3 provides the detailed risk-return statistics of the three indices shown in the figure above. Even though ILS hedge funds have generated consistent performance with low correlation against other financial assets, the losses they suffered during the 2017 and 2018 Atlantic hurricane seasons dealt a blow to their short-term risk-adjusted returns.

Table 3: Eurekahedge ILS Advisers Index performance

Eurekahedge ILS Advisers
Index

Eurekahedge Fixed Income Hedge Fund Index

Merrill Lynch Global Government Bond Index II

2008

3.83%

(10.99%)

8.88%

2009

8.99%

25.10%

0.86%

2010

7.52%

12.98%

3.64%

2011

(0.14%)

4.41%

6.09%

2012

5.93%

11.67%

9.08%

2013

7.61%

5.88%

(4.67%)

2014

5.42%

4.41%

8.37%

2015

4.24%

1.04%

1.22%

2016

5.19%

6.67%

2.96%

2017

(5.60%)

6.54%

1.16%

2018

(3.92%)

0.10%

0.99%

October 2019 year-to-date

1.97%

6.43%

6.66%

3-year annualised return

(2.41%)

4.60%

2.33%

3-year annualised volatility

5.75%

1.77%

2.96%

3-year Sharpe ratio (RFR = 2%)

(0.77)

1.47

0.11

5-year annualised return

0.39%

4.02%

2.99%

5-year annualised volatility

4.58%

2.10%

3.19%

5-year Sharpe ratio (RFR = 2%)

(0.35)

0.96

0.31

Source: Eurekahedge

Figure 4 below provides the yearly asset flows and AUM of the ILS hedge fund industry over the recent years. Following two consecutive years of performance-based losses, the industry has witnessed US$7.1 billion of investor redemption in 2019.

Figure 4: Annual asset flows and AUM of the ILS hedge fund industry
Annual asset flows and AUM of the ILS hedge fund industry

Capturing opportunities in digital assets

The second day of Altinvestor Zurich 2019 started with a presentation on opportunities and risks around digital asset investments from a Switzerland-based private investment firm. The high risk-adjusted performance and low correlation to traditional asset classes have attracted institutional investors over the past few years. Surveys have found that sophisticated tech investors, family offices, endowments and family offices have begun to enter this disruptive space in search for long-term outperformance.

The complexity of digital asset technologies has acted as a major barrier of entry for less sophisticated investors without the necessary specialised knowledge, but the increasingly accommodative regulatory policies and the high rate of adoption would encourage asset owners to tap into the fast-growing sector.

Figure 5 illustrates the performance of the Eurekahedge Crypto-Currency Hedge Fund Index, an equal-weighted index comprising 29 unique hedge funds utilising various crypto-currency trading strategies. These funds have generated an annualised return of 105.85% since the beginning of the index, which compares to the 105.11 % annualised return of the Bitcoin.

Figure 5: Eurekahedge Crypto-Currency Hedge Fund Index performance since June 2013
Eurekahedge Crypto-Currency Hedge Fund Index performance since June 2013

Table 4 compares the annual performance and risk-adjusted returns of the Eurekahedge Crypto-Currency Hedge Fund Index against those of the Bitcoin Price Index. Despite their vast outperformance over Bitcoin in 2017, crypto-currency fund managers have lagged behind following the early 2018 market crash.

Table 4: Eurekahedge Crypto-Currency Hedge Fund Index performance

Eurekahedge Crypto-Currency Hedge Fund Index

Bitcoin Price Index

2013

905.78%

676.84%

2014

(54.25%)

(57.80%)

2015

57.56%

34.52%

2016

90.34%

125.14%

2017

1,708.50%

1,331.49%

2018

(71.81%)

(72.11%)

October 2019 year-to-date

37.62%

138.65%

3-year annualised return

107.08%

136.50%

3-year annualised volatility

94.56%

97.29%

3-year Sharpe ratio (RFR = 2%)

1.11

1.38

5-year annualised return

81.54%

93.87%

5-year annualised volatility

79.11%

82.95%

5-year Sharpe ratio (RFR = 2%)

1.01

1.11

Source: Eurekahedge

Southeast Asia: Why it matters

Another highlight of the second day was a presentation on the investment opportunities in Southeast Asia, brought by a representative of a New York-based single family office. Slowing economic growth resulting from the escalating US-China trade war has pushed institutional investors’ attention to the region of 11 countries representing a population of 630 million and a combined GDP of US$2.5 trillion. The fast-growing economies of the ASEAN countries present a multitude of opportunities which have attracted investors in a time when China is slowing down. The region’s exploding tech sector (e-commerce, online travel, online media, ride hailing) driven by digital transformation has attracted venture capital investments from the west, as well as China. As of 2019 there are 14 unicorns in the region, and the region saw over US$7.2 billion invested across more than 300 deals in 2018. The huge unbanked population and availability of young tech-trained labour force present enormous growth opportunities for Fintech companies in the region in near future.

Roundtable discussion: hedge funds

This year’s Altinvestor Europe round table on hedge funds featured a German multi-family office which utilises a quantitative approach to screen hedge fund managers by analysing the factors driving their returns. Allocation decisions are made based on the amount of returns not attributable to factors easily replicable through other investment vehicles over a minimum track record of five years. It was also highlighted that such a rigorous screening process could cause the investors to miss out on emerging managers (which lack the track record) and thus potentially lean heavily toward relatively larger, more institutionalised hedge funds, which in some cases have generated diminishing alpha over time due to the increase in size and decrease in agility to exploit market inefficiencies. Another key theme discussed was how the changes in market structure, central bank interventions and low interest rates over the recent years have affected hedge fund performance.

Figure 6a and Figure 6b illustrate how the various hedge fund strategies have performed against a spectrum of mixed equity-bond portfolios in terms of annualised return and annualised volatility. Figure 6a provides the risk-return statistics over the last five years, while Figure 6b provides the same data over the period starting end-2007.

Figure 6a: Asset allocation and hedge fund risk-return profile (last five years)
Asset allocation and hedge fund risk-return profile (last five years)

From the two figures, it could be observed that hedge fund returns have generally fallen relative to the performance of equity and bond markets over the recent years. The largest differences could be observed on distressed debt, CTA and ILS hedge fund strategies, reflecting their weak returns over the last five years in comparison to what these strategies have achieved in the past. ILS hedge funds in particular have suffered two consecutive years of losses due to the recent Atlantic hurricane seasons of 2017 and 2018, wiping out a substantial part of the gains they recorded in the preceding years.

Figure 6b: Asset allocation and hedge fund risk-return profile (since end-2007)
Asset allocation and hedge fund risk-return profile (since end-2007)

The full article inclusive of all charts and tables is available in The Eurekahedge Report accessible to paying subscribers only.

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