What is a Hedge Fund? Is it really evolving?

We start from a recent article from Bank of America Merrill Lynch “As hedge funds evolve, what should IROs know?” – published on IR Magazine Summer 2016 – to discuss the ongoing evolution of the hedge funds industry and the change in the relation and the dialogue between hedge funds and IROs.
We certainly all know what hedge funds are. With a growing amount of assets – and the freedom to invest opportunistically worldwide – hedge funds have become one of the most important market-moving forces of the last few decades.
Literally, a hedge fund is a fund that can take both long and short positions, use arbitrage, buy and sell undervalued securities, trade options or bonds, and invest in almost any opportunity in any market where it foresees impressive gains at reduced risk. What less people are aware of is that hedge fund strategies vary enormously which is especially important today with volatility and anticipation of corrections in overheated stock markets.
While many hedge funds do invest in traditional securities, such as stocks, bonds, commodities and real estate, they are best known for using more sophisticated (and risky) investments and techniques. Hedge funds typically use long-short strategies, which invest in some balance of long positions and short. Additionally, many hedge funds invest in “derivatives,” and many hedge funds also use an investment technique called leverage, which is essentially investing with borrowed money—a strategy that could significantly increase return potential, but also creates greater risk of loss.

As BofAML points out in the article we selected, the hedge fund industry is changing, and it has become easier to access information about the operations of large funds – a trend she expects will continue. According to the bank, hedge funds, are not defined by a strategy but by a structure so not all hedge funds are the same. It almost sounds like an oxymoron: long-only hedge funds. In fact, a common misperception is that hedge funds are fast money, trading a stock within minutes (or even seconds) of acquiring it. Another popular misconception is that all hedge funds are volatile – that they all use global macro strategies and place large directional bets on stocks, currencies, bonds, commodities, and gold, while using lots of leverage. In reality, less than 5% of hedge funds are global macro funds. Most hedge funds use derivatives only for hedging or don’t use derivatives at all, and many use no leverage.

We might still ask to ourselves whether the hedge fund is positive or negative. This year, hedge funds, and not only them I would add, have faced some serious challenges, experiencing $15.1 bn in investor outflows during the first quarter, according to Hedge Fund Research. Obviously, macro issues, disappointing earnings growth and uncertainty about events on the world stage, such as the fate of the European Union and who will lead the US after the election, have hurt markets. Said that we are convinced there’s far more investable capital now than there was after the financial crisis in 2008 through 2011. And most probably, also for this reason, the hedge fund industry will continue to grow.

Only recently IROs have begun to re-evaluate how they view hedge funds. It looks like they are moving from suspicion to a more welcoming stance. In our view, this is a positive change, especially when we consider that there have been some very good partnerships over time between IR professionals and hedge funds. Hedge funds and IROs are on a much better footing today also because hedge funds themselves have evolved. A 2015 EY report, ‘The evolving dynamics of the hedge fund industry’, uses the terms ‘seismic shift’ and ‘profound transformation’ to describe what’s under way.
As signs of this evolution, hedge funds include some household-name firms with impressive assets. In addition, the profiles of these hedge funds are making them increasingly attractive to IROs as potential investors. Another reason IROs are reconsidering hedge funds is the absolute size of assets these funds command: according to Barclay Hedge, hedge fund assets under management grew to $2.8 tn in 2015, up from $1.5 tn in 2008.
Hedge fund teams do extensive homework ahead of companies’ meetings, and IROs should be always well-informed, expecting in-depth questions from them. Also, when meeting with a given hedge fund manager, it makes sense to find out whether he or she has a global or domestic mandate, and whether that manager covers a single sector or the market more broadly.

In the end, it is encouraging that IROs are keen to meet with all types of investment managers: you can interact with hedge funds and keep working with them and this can be a very worthwhile relationship.
And do not forget: many have the ability to act very quickly and meet with a management team in the morning and then to acquire a position that very same day.

Simona D'Agostino Reuter

Simona is a finance professional with 15 years experience in Investor Relations and Financial Communications and a lengthy track record in both B2B and B2C companies. For several years, she has been Head of IR for the blue-chip group and gaming leader Lottomatica-GTECH (now IGT, listed on NYSE), based in Italy and in the US. She gained overtime an extensive experience in IR and in managing investor perceptions also through difficult transitions and challenging times.