5 Major Themes For Hedge Fund Investors In 2012

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2011 was a mixed year for the major hedge funds.  Renaissance Technologies, the statistical arbitrage fund with mythical returns, had another banner year.  While John Paulson, the genius who shorted subprime, got crushed.Through November, the HFRI Fund Weighted Composite–an index of hedge fund returns–was down 4.5%.

2012 is likely to be another mediocre year, suggests Rui De Figueiredo of Morgan Stanley Smith Barney (MSSB) and professor at the Haas School of Business.

“Will 2012 be a continuation of 2011’s lackluster performance, or will hedge funds behave as they did in 2009 and 2010? Our anticipation is that the answer lies somewhere between the extremes and that hedge funds will be in a position to provide what investors want from them: value-added performance with
respect to traditional markets,” he writes.

In a new note to MSSB clients, De Figueiredo lists five key themes for hedge funds in 2012.

Good climate for global macro strategies

'We expect episodes of heightened volatility to provide sufficient trading opportunities for discretionary macro managers. More specifically, we believe divergent central-bank policies in emerging versus developed regions will drive opportunities in interest rates and currency trading.'

Source: Morgan Stanley Smith Barney

Still bullish on mortgage strategies

'Many managers and hedge fund allocators have done very well over the last two years through trading in mortgage-backed securities, and we do not see a cessation of these opportunities this year. Specifically, we favour the excess spread in credit-sensitive mortgage products relative to high yield corporate credit. We also believe that prepayment-driven strategies in mortgages have the potential to produce continued attractive returns, since it is unlikely that there will be a policy resolution to the mortgage situation in an election year.'

Source: Morgan Stanley Smith Barney

Bank deleveraging and regulation

'We anticipate banks will continue to shrink their balance sheets, which may allow hedge funds to buy assets at attractive prices. In addition, regulations--such as the Volcker Rule, which restricts speculative trading-- will encourage banks to step back from traditional trading activities, allowing hedge funds to fill the gap. Reduced competition and continued selling could offset market headwinds with attractive opportunities.'

Source: Morgan Stanley Smith Barney

Capacity constraints

'In recent years, many hedge funds have closed-- although successful ones continue to attract substantial capital. That means investors may find it harder to put new money to work in hedge funds this year. Still, we expect that today's limited capacity will create opportunities and incentives for innovative entrants to launch new funds.'

Source: Morgan Stanley Smith Barney

Manager selection

'When market volatility dominates performance, manager selection is often tantamount to market selection. Because we expect correlations among securities to decline from their peak levels, the dispersion of performance results among managers will likely widen. Indeed, such a trend has already started with the recent increase in the variation of returns of managers within the same strategy. In this context, manager selection within strategies will be as important as strategy allocation.'

Source: Morgan Stanley Smith Barney

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