Stronger flows to hedge fund and absolute return strategies last year should increase during 2011, according to Fitch Ratings.

In a hedge fund sector update, the international ratings agency said the increase is partly due to a drive from institutional investors to seek diversifying sources of performance and downside risk protection.

The change is structural, as regulatory changes push institutional investors to take active risk while satisfying regulatory de-risking of their balance sheet, Fitch said. The general perception of market asymmetry has also driven the shift.

Fitch said hedge funds and most absolute return strategies served their purpose in 2010 and Q4 2010 on a risk-adjusted performance basis, while regulated funds managed by hedge fund managers have had disappointing performances, somewhat questioning the validity of the segment.

Commenting, senior director in Fitch's fund and asset manager rating team Manuel Arrive said: “Investors which were recently attracted to absolute return products for their downside risk protection characteristics also need to recognise that these strategies may not be able to fully capture market upside.”

Global macroeconomic imbalances combined with trend reversals provided opportunities to relative value-oriented strategies, Fitch said. Meanwhile, rising risk appetite and the short-lived appearance of clearer macro trends in Q4 favoured alternative directional strategies until another sharp trend reversal in late February 2011.

Looking ahead, current valuations, rising geopolitical risks, potentially weaker growth, higher inflation and on-going fiscal consolidation are driving a reassessment of some of the long beta calls which were successful last year, such as credit, emerging markets, and equities.

Fitch said the current uncertainty should further support interest in absolute return strategies.

Share Story: