Outlook Improving for Hedge Funds, But Uncertainty Remains

Moody’s says the hedge fund industry is showing signs of a recovery from the crisis and this is likely to continue in the near term. In a new Industry Outlook for 2010 available for complimentary download the rating agency says that the positive trends merit a degree of caution, especially as a number of individual failures occurred during the crisis and some funds are still dealing with the aftermath.

Moody’s believes the industry as a whole is successfully adapting to the new market conditions and is recovering as performance improves and investors begin making allocations to hedge funds. The recovery should continue in 2010, barring another major economic shock or regulatory shifts. The report also indicates that net inflows and new start-ups will likely increase, albeit at subdued rates, and fund managers will very likely continue expanding their product offerings beyond hedge funds, testing different markets.

The report cautions that these positive trends are largely dependent on economic conditions and investor confidence, as well as the global regulatory and taxation environment, which will remain sources of uncertainty in the coming months.

Another systemic shock or reputation damage caused by a large-scale failure may have knock-on effects on investor confidence and, if sufficiently severe, could undermine the foundations of the recovery.

The report also shows that hedge funds are not immune to market shocks: “This stands to reason, because, although it is true that risk exposures of funds can vary substantially, they are participants in the financial markets and a sudden re-pricing of risk across the board can catch managers off guard, in the same way as other market participants. “A simple analysis using the VIX index as a measure of panic illustrates the point: we can observe that most (industry-wide) negative returns are associated with VIX spikes.

The full reportHedge Funds: 2009 Review and 2010 Outlook has been made available for free download to Research Recap users for 30 days by special arrangement with Moody’s, an Alacra content partner. (After 30 days the report will revert to its regular AlacraStore price of $550.00)