With the overall popularity of long/short equity funds, it is not surprising that in May the BHA research team identified 126 accredited investors that were focused on evaluating new long/short managers. Also not entirely surprising is the preference for the strategy from funds of funds, wealth advisors, and family offices, which combined made up more than 70 percent of the total number of investors interested in long/short equity funds.

It is a bit unexpected, however, that private banks made up 12 percent of total long/short interest last month.

Apparently, private banks have become more positive on hedge funds as of late. According to an article in Reuters, private banks think that “ …hedge funds were no riskier than forex or equities, and should be included in portfolios for reasons such as diversification and their ability to make money in falling markets.”1

Specifically, some private banks are favoring long/short equity strategies. As noted in the Reuter’s article, “Barclays Wealth suggests clients shift part of their equity holdings into long-short funds that are better able to take advantage of choppy stock markets.”1

Although not every private bank active in the hedge fund space thinks long/short equity is the best or most attractive strategy, there are two underlying consistencies among those that do.

First, there is a strong preference for UCITS III-structured long/short funds. Eighty-five percent of the European-based private banks contacted by BHA will evaluate only UCITS-structured hedge funds.

Second, even though private banks as a whole are more positive on hedge funds, many of the investors BHA analysts spoke with are still being cautious. By and large, they still prefer managers with a significant track record and do not want their allocation to account for more than 10 percent of a fund’s total assets.

As we move into the second half of 2010, it is clear that long/short equity funds will maintain the popularity that presently surrounds them. If the market continues to be as turbulent as it has been of late, that popularity should increase, as more investors look for market downside protection. Private banks will then be just one category of accredited investors evaluating managers more closely in the long/short space over the next six months.

1 Reuters.com, “Asia private banks favour event-driven hedge funds,” May 25, 2010.

In a month where global market activity has been undoubtedly turbulent, there has been a bright spot that may shift the focus of many investors. According to Hedge Fund Research’s month-to-date data, the HFRX Equity Market Neutral Index is the only index with positive performance in May. As of May 28, performance was at 1.61 percent, compared with the Global Hedge Fund Index at -3.00 percent, the Equity Hedge Index at

-4.37 percent, and the Macro Index at -0.81 percent.

Since April 1, 2010, the BHA research team has spoken to 81 investors that are actively researching and allocating to market-neutral funds. Those 81 investors account for more than 20 percent of the total number of firms that the research team identified during the past two months.

Although these numbers are not overwhelming, we expect to see more investors change their focus to equity market-neutral funds. The recent market dip during the past few weeks is causing investors to reevaluate their current investment preferences. But for some, investing in market-neutral funds is unfamiliar territory. According to a fund manager running a large market-neutral fund, this type of investment should be a part of every portfolio; market-neutral funds allow for stable, low-risk returns regardless of the current market activity.1

An analyst at a large wealth advisor based in Geneva told BHA analysts that his firm has plans to allocate upwards of $20 million to at least three market-neutral funds by year’s end. The firm is more interested in equity market-neutral funds than it was last quarter, due in large part to the recent activity in the market. It is most interested in funds offering a UCITS III structure, which when combined with its interest in market-neutral funds, will ensure the firm is lessening its risk.

A small family office based in Florida is also predominately interested in equity market-neutral funds; it has plans to invest $2 million to $5 million during the next few months. The firm is evaluating this strategy simply because of the ratio of positions. In the past, the firm has found that many funds that claimed they were long/short held too many long positions, which is exactly what the firm does not want. Market-neutral funds allow it to feel more comfortable toward future commitments.

While market-neutral funds have the potential to provide diversified returns and improve portfolio performance, individual fund performance is largely the result of the fund’s design and construction, and the portfolio manager’s skill. This means that it is critical for investors to analyze past performance. Noting that caveat, investors are still actively researching equity market-neutral funds in order to truly find the best places to put their money.

1 The Wall Street Journal, “Sometimes It Pays to Be ‘Neutral’,” May 26, 2010.

During the past year, many in the hedge fund industry have voiced the opinion that funds of hedge funds are dead. They say this because many investors have been scared away from funds of funds. Liquidity concerns, transparency issues, and the general fee structure of these multi-manager vehicles have deterred investors. An analyst at a Canadian-based family office described the space of late as “barren,” but he still remained optimistic about the upside that seems to him inevitable. With total industry assets at $1.67 trillion—just 2 percent shy of the high-water mark—he believes investors will return.

That said, renewed interest in funds of funds isn’t going to happen without change. Many institutional investors that were previously nervous about allocating to funds of funds, are now taking matters into their own hands. According to an associate director at Fitch Ratings, “Institutional investors want to be more directly involved in hedge fund selection and FoHF managers are expected to act more as solution providers, via managed accounts or advising services.”1

Many managers have realized that such changes are necessary in order to overcome the concerns that caused the drop in investor interest. In addition, as investors take a more hands-on approach, it is widely expected that managers will be forced to lower fees. A number of managers are launching funds that are UCITS-III compliant to address liquidity and transparency concerns.

Looking at the BHA network for the past four months of the year, the research team has identified 233 investor mandates from investors interested in allocating to funds of hedge funds this year. That represents a significant increase from a year ago, when BHA collected only 175 mandates during the same time frame.

For many, the reason to invest in funds of funds is for the diversified exposure they offer. However, in addition to the changes mentioned previously, a large number of investors want to only invest in managed accounts. This is the requirement of a large university endowment located in the western U.S. After taking three-months to evaluate and restructure its portfolio, the directors of the endowment decided to allocate roughly $25 million to a large fund of hedge funds that offers managed accounts.

1 Hedgeweek, “Fund of hedge fund seen renewed inflows,” April 19, 2010

During the past 90 years, whenever the DJIA 12-month rate of change exceeded 40 percent, market turmoil usually lay ahead. On eleven of the 13 occasions, significant market corrections followed.1 For the period from March 2009 to March 2010, the rate of change once again reached above 40 percent. If the trend stays true, investors may be about to see another correction. Although such markets can be painful, they can also be an opportunity for event-driven funds.

Event-driven investment managers typically look to capitalize on corporate activities or transactions, such as mergers and acquisitions, restructurings, reorganizations, spin-offs, asset sales, liquidations, and bankruptcies.2 Although some transactions, such as M&A, tend to be products of good markets, many others occur in bad or unpredictable markets.

The risks for corporate transactions are many: they can take longer to negotiate than anticipated; they can be negatively affected by changes in the market; and they may have to win regulatory approval, just to name a few. Sometimes a given transaction is altogether abandoned. Still, current investor appetite for event-driven funds is strong.

In the month of March, the BHA research team spoke with more than 186 investors from all investor categories. Twenty-five percent showed an interest in event-driven funds. This level of interest in event-driven funds has held fairly steady since the first of the year. For example, a large university endowment in the Northeast mentioned a keen interest in the event-driven space. The endowment prefers funds that manage a single pool of capital and pursue a coherent investment philosophy.

It is unclear if investors are expecting turmoil in the market. Some may be chasing returns—event-driven funds’ performance has improved—while others may be taking advantage of the large number and variety of opportunities currently available. Whatever the reason, investors allocating to these funds now should find themselves well-positioned for the future. And if history repeats itself, more opportunities will be on the way.

1 Business Insider, “90 Years of History Suggests A Move Like This One Is Followed By A Market Bust,” March 31, 2010.

2 Investopedia.com, “Hedge Funds Hunt For Upside, Regardless of the Market.”

It is no secret that investor interest in Japan-focused hedge funds has been quite low for many years. Recently, as investors have become more comfortable with the market and have begun to put their money back to work, Japan-focused funds have struggled significantly relative to funds focused on the region. According to the annual data analysis from Eurekahedge, Asia-focused funds—with the exception of Japan-focused funds—returned possibly their best year to date in 2009, gaining nearly 40 percent.1 And as we have moved into 2010, Japanese funds are becoming even more intriguing.

Through the end of February, “Japanese hedge funds have seen slightly positive asset flows so far this year, compared with outflows from the rest of Asia.”2 Investors are beginning to take notice, and even after redundant disappointments in past years, many believe that 2010 is the year for Japanese funds. In a recently released report, a prominent hedge fund chief executive stated that, “many institutions are massively underweight Japan and it’s time to get up to neutral weighting on the country.”3 Investors seem to be taking a liking to funds focused on small- and mid-cap Japanese companies that are in a position to benefit from growth in Asia and emerging markets.

These trends are reinforced by the research performed by the BHA analyst team on a daily basis. While not overwhelming, interest in Japan-focused hedge funds is rather significant, following a period where interest in the country was minimal. Since the start of the fourth quarter of 2009, the BHA team has spoken to more than 50 investors, ranging from small family offices to large university endowments, all of which have a genuine interest in Japanese funds.

A university endowment based in the U.S. recently told BHA analysts that Japanese long/short equity funds are of particular interest right now. The endowment recognizes that Japanese funds have been unstable for some time and, therefore, it will only allocate to fund managers who have dedicated their careers to learning the Japanese market and have experienced the ups and downs. With that said, the investor sees great upside potential in such managers for the near future.

While confidence in Japan-focused hedge funds may be shaky, it is hard to ignore positive returns. Investors are becoming more and more interested month over month as fund managers gain confidence in their abilities to net positive returns in a once bleak marketplace.

1 Absolute Return + Alpha, “Hedge Funds to Continue 2009 Growth in New Year,” January 20, 2010,

2,3 Thomson Reuters, “Japan hedge funds see increased interest,” March 2, 2010.

Long/short equity funds have long been the preference for institutional and private investors active in the alternative investments space. This trend is one that is not stopping anytime soon. Despite that the LAB Long/Short Index dropped 1.46 percent in January, investor demand for the liquid strategy increased significantly.

The increase in demand for long/short funds since January 2009 is staggering. During January 2010, BHA’s team of analysts spoke with 181 investors that indicated an interest in researching and reviewing long/short equity funds. This is striking when compared with investor sentiment a year ago when 87 investors expressed interest. Even the comparison between December 2009 and January 2010 is significant: the number of investors interested in long/short equity funds more than doubled in one month’s time.

Granted, these investors are quite different from one another in terms of the funds they will choose for allocations, but one thing remains the same – long/short equity funds allow for redemptions and transparency that are favorable in this recovering market. Just ten days into February, the BHA team has spoken to more than 45 investors looking for long/short equity funds. It will be interesting to see how these funds perform over the next few months, but as the market continues to rebound, it is safe to say that demand for long/short funds is not going away.