Despite stellar show, domestic hedge funds unlikely to draw big from investors

India-focused hedge funds delivered a solid 38.95 per cent return in January-November 2014, trumping the benchmarks BSE Sensex and NSE Nifty in what has been a very good year for equities. But despite the outperformance, investors aren’t expected to make a beeline for these funds in 2015, on account of the high volatility of returns of Indian funds, according to Hassan Mohamad, an analyst with alternative investments data provider and research house Eurekahedge.

“India-dedicated managers will need to repeat their performance of 2014 much more consistently going forward to attract any serious attention from investors,” says Mohamad. According to Eurekahedge, Indian hedge fund performance leaves much to be desired, given that they were down 50.66 per cent in 2008, up 49.42 per cent in 2009, down 22.9 per cent in 2011, up 12.84 per cent in 2012, down 8.52 per cent in 2013 and up 34.34 per cent in 2014.

The allure of Indian hedge funds is also limited when viewed from the perspective of performance relative to underlying markets over the last seven years.

“For investors, the added fees of a hedge fund set-up cannot adequately justify this performance,” says Mohamad. Hedge fund investors, while desirous of high returns, also seek such funds as a hedge against market vagaries and in this sense, India-focused funds have failed to keep up to expectations.

“The much-valued downside protection that hedge funds traditionally offer to investors has also been absent in the case of domestic hedge funds. Thus, investors could be better off putting their money in a simple long-only investment fund that charges lower fees and usually more upside,” says Mohamad.

India-focused hedge funds utilise three main strategies, according to Eurekahedge. These are a long-short strategy on equities, a commodity trading advisor (CTA)/managed futures approach laying emphasis on futures contracts in their overall investment strategy and a multi-pronged approach that utilises both these strategies as well as a fixed income hedge.

The clear winner in 2014 was the long-short equity funds, which delivered an astounding 53.9 per cent return in the first 11 months of the year, in comparison to 27.2 per cent return from managed futures funds and 26.1 per cent from multi-strategy funds.

Consequent to the poor performance in past years, the size of the domestic hedge fund industry has fallen well below its peak of $5.2 billion in 2008 to approximately $2.91 billion now. That’s just a fraction of the total global industry, which has $2.13 trillion of assets under management. A total of 65 funds are operational in the country and the average size of a fund is $44 million, with their median size pegged at $19.5 million, according to Mohamad.

“The Indian hedge fund industry… is composed of mainly small-tier funds and for the last couple of years has been recovering primarily on the basis of performance-driven gains. Investors still have some key concerns when allocating to an India-dedicated hedge fund,” says Mohamad.

Nevertheless, the fact remains that the sterling performance of domestic hedge funds in 2014 is likely to have attracted the eyeballs of many investors. A perusal of the returns of the global hedge fund industry reveals that their average return during January-November 2014 in dollar terms was 4.37 per cent.

It is more likely that hedge fund investors will take exposure to the Indian market through an alternate route, he adds. “Investors generally want to avoid concentrated country-specific exposure, hence the recent inflows have been directed towards Pan-Asia funds which can carry some exposure to Indian markets,” says Mohamad.

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