Aurora Borealis
1 May 2015 CFA Institute Journal Review

European Hedge Funds Industry: An Overview (Digest Summary)

  1. Lawrence Gillum, CFA

Given the rapid growth in hedge funds in the European market and the absence of literature directed at this market, the authors attempt to fill the void by analyzing the growth, structure, and performance of European hedge funds. They conclude that this market now rivals the North American market.

What’s Inside?

Since 2000, the amount of European assets invested in locally domiciled hedge funds has increased at a greater rate than the amount of assets in their North American counterparts, prompting the authors to examine the dominant fund characteristics as well the funds’ performance relative to that of North American hedge funds and other benchmarks. They conclude that European hedge funds are and will remain a strong competitor to US funds in terms of trading strategies and performance. Moreover, despite the recent European crisis, funds continue to attract assets by improving governance, transparency, and back-office operations, indicating that the industry should continue to attract assets in the future. The advent of new regulations is a primary reason that the authors believe the competition between the two regions will become more acute.

How Is This Research Useful to Practitioners?

Hedge funds have become a strategic allocation for many institutional investors. In fact, by the end of 2012, more than $2 trillion globally was invested in one of the many funds/strategies that fall under the hedge fund umbrella.

Most hedge fund studies are directed at the industry broadly and not the distinguishing characteristics among funds that are regionally domiciled. The authors remedy this oversight by analyzing funds that invest exclusively in Europe, which represents roughly one-third of European funds—a total of $164 billion as of 2012, down from its peak of $256 billion in 2011. According to the authors, the growth of the European hedge fund industry is the result of several factors—for example, the abundance of service providers (prime brokerage, administration, custody, and auditing), especially in London. In addition, the United Kingdom offers many structural advantages, including proximity of clients, markets, and local expertise, which make it an attractive place for hedge fund management. Because the European hedge fund industry has seen sustained asset growth, the authors believe it is important to examine its characteristics and performance so as to understand the role of this sector in the global industry.

They introduce and explain the 14 hedge fund strategy classifications and, importantly, compare the strategies’ performance with that of the respective North American counterparts as well as an appropriate passive index. Of the strategies reviewed, long–short equities (30%), fixed income (25%), and relative value (20%) are the largest strategies by assets. Interestingly, in 2000, the long–short equities strategy represented 74.42% of assets under management (AUM) but by 2012 had lost approximately 45% of market share. In the same period, the event-driven strategy lost 10.5% of market share, whereas the relative value and the fixed-income strategies gained 20% and 25%, respectively.

Finally, the authors examine hedge fund performance according to strategy and find that most hedge fund indexes perform better than stock and bond indexes and have lower volatility. In the three largest segments—long–short equity, fixed income, and relative value—European performance is competitive with that of its North American peers but generally outpaces the indexes with less volatility. Therefore, the authors conclude that European hedge funds are a strong competitor to North American hedge funds.

How Did the Authors Conduct This Research?

The authors consider all European hedge funds that invest exclusively in Europe by using the Eurekahedge database, which is one of the most extensive hedge fund data sources and provides data on both live and defunct funds beginning in 1999. The sample contains 1,905 hedge funds (both live and defunct) as of December 2012. Dissolved funds are also included to mitigate the impact of survivorship bias.

To analyze the evolution of the European hedge fund industry, the authors use monthly AUM from January 2000 to December 2012. To further delineate the industry, the authors use data from Eurekahedge to parse the universe into 14 strategy categories (arbitrage, bottom up, commodity trading advisers/managed futures, distressed debt, diversified debt, dual approach, event driven, fixed income, long–short equities, macro, multistrategy, relative value, top down, and value) and provide an index for each strategy. Next, they use monthly returns of these indexes to analyze the performance of investment strategies used by hedge funds investing in Europe.

Finally, to compare the monthly performance of hedge funds investing in Europe with that of other benchmarks, the authors use the Eurekahedge Europe and North America indexes alongside the MSCI Europe index and the Barclays Capital Euro Aggregate Bond Index. Cumulative performance and annual returns, alongside appropriate risk measures, are presented for the period of study for each of the 14 strategies (organized into directional and nondirectional categories) in both Europe and North America. For example, between January 2000 and December 2012, the long–short strategy generated average monthly returns of 0.69% for US managed assets and 0.75% for European managed assets versus 0.14% for the MSCI Europe Index; the monthly volatilities are, respectively, 2.17% and 2.35% versus 5.78%.

Abstractor’s Viewpoint

The authors provide a tremendous amount of comparative analysis of the European hedge fund industry against its North American peers in terms of both relative performance and strategy characteristics and show that the growth in the industry has been impressive. And although the authors’ conclusions may be fair, it will be interesting to see whether regional domicile is, in fact, an important attribute to the end client. Transparency, liquidity, and, of course, performance continue to be important attributes for investors; as long as these attributes are satisfied, location may not be as important. That said, it is encouraging that investors have a truly global opportunity set when searching for hedge fund strategies.

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