Liquidity and transparency have been the watch words of investors since the financial crisis. Recently, however, BHA analysts noted another trend in the hedge fund community. Investors are looking to fixed-income hedge fund strategies for consistent returns, and managers have indicated that they are seeing steady growth in this area.

Before the financial crisis in 2008, hedge funds were largely viewed as vehicles that offered investors an exciting opportunity to earn higher returns by being exposed to slightly higher risks. Since the crisis, investors have been cautious and, as a result, investments in hedge funds have decreased substantially.

However, inflows may be on the rise again. Between April 30, 2009, and April 30, 2010, there was an estimated 36 percent increase in trading volume among hedge funds, according to a survey by Greenwich Associates: “The total trading volume among the 245 hedge funds that responded to the 2010 survey jumped to $4.7 trillion from $2.8 trillion in the year ended April 30.”

One reason for the increase is investor interest in fixed-income securities. Prior to the financial crisis, many investors were not as captivated by vehicles such as Treasurys, government bonds, interest rate swaps, and agency securities. They were perceived as boring and had seemingly become out of date. However, in this postcrisis world, interest in many of these staid fixed-income strategies has rebounded among investors and managers alike, and riskier investing has dropped off. The same report noted, “From April 30, 2009 to April 30, 2010, a matched sample of hedge fund survey respondents revealed a 73% increase in Treasury’s trading volume. Hedge funds constituted 3% of trading volume in government bonds as of April 30, 2009. That share in trading volume jumped to about 20%, as of April 30, 2010, increasing 60% year-over-year.”

BHA data supports this trend. About 20 percent of the hedge fund investor mandates that BHA has received over the past month and a half have mentioned an interest in fixed-income and fixed-income arbitrage strategies. But have analysts seen any rise in fixed-income investor interest after April 30, 2010? Indeed, there has been a slight rise. Investors interested in fixed-income and fixed-income arbitrage hedge fund strategies rose 17 percent from May through July. A wealth advisor in London, as well as a family office in Illinois, explained to analysts that they are seeking exposure to sovereign and corporate debt rather than some of the more volatile strategies like global macro.

A sign that this trend may persist at least near term, some hedge fund managers are adding fixed-income funds and expertise to their offerings. A large wealth advisory firm in London is a prime example. It recently hired an experienced fixed-income manager to look over the firm’s UCITS III-compliant fixed-income funds. The chief investment officer said, “The asset class has always played an important role at the heart of our client portfolios, and has made a significant contribution to our long-term performance track record, delivering our clients an annualized return of some 10% per annum.”

Although some investors are still allocating to hedge funds in order to earn large returns by taking on slightly higher risk, many are looking to a variety of debt instruments that can produce more predictable and absolute returns. Although investor interest in this area is rising now, only time will tell if it will continue for the remainder of 2010.

To spot worldwide investor trends, BHA analysts periodically step back from the day-to-day news and investor conversations and look at the big picture. They did this recently, evaluating BHA hedge fund investor mandates from April 1 through mid-July and comparing them with mandates from the same period a year ago. There was a noteworthy difference. In the 2010 time frame, 120 investor mandates specified the commodities sector as a major interest. Last year during this period, only 70 mandates included commodities. This represents a significant increase of 71 percent from 2009 to 2010.

Over the past month, BHA has interviewed a wide variety of investors around the globe. Whether they were family offices, corporate pensions, consultants, fund of funds, or wealth advisors, many of them expressed an interest in increasing their exposure to commodities. Despite the volatility and uncertainty in the marketplace this year, these alternative investors saw commodities as an opportunity to offset equity risk with potential growth and stability.

A family office in New York, for example, stated that it is specifically seeking funds focused on commodities. The firm mentioned that it is researching a variety of strategies including asset-based lending, credit, CTA/managed futures, distressed, and emerging markets.

A fund of funds investor based in Austria has also shifted its interest to the commodities area. Previously the firm was primarily focused on global macro hedge fund managers, but recently it told BHA analysts that it is seeking CTA managers for new investment opportunities in 2010.

There may be another explanation for rising commodity interest. Investing in commodities can be an effective hedge against rising interest rates. The Federal Reserve pushed up the discount rate to .75 percent in mid-February for the first time in over three and a half years, and this is likely to occur again.

“Portfolios that add commodities after the Federal Reserve tightens the discount rate, perform better than portfolios that don’t,” stated Wall Street Journal writer, Carolyn Cui.1 She came to her conclusion after analyzing data on a new study that will be published in the Journal of Investing. The authors of this study researched data from December 1970 through August 2007.

To explain the process, Cui stated, “The researchers added a basket of commodity futures tracking the S&P GSCI Commodity Index to five types of stock portfolios: value, small-cap, momentum, growth and large-cap. The commodities added to the returns of all five equity styles during periods when the Fed tightens the discount rate.”

Whether to offset equity risk or hedge rising interest rates, investors around the world are beginning to see positive investment opportunities with commodities-related funds. Confidence has truly grown and only time will tell if commodity interest will continue to rise in the future.

1 Dailymarkets.com “Investing In Commodities: A Hedge Against Rising Interest Rates” April 26, 2010, http://www.dailymarkets.com/forex/2010/04/26/investing-in-commodities-a-hedge-against-rising-interest-rates/.