Volatility revives appeal of relative-value funds

Relative-value arbitrage funds are one of the main hedge fund strategies to benefit from mis-priced assets, says Lyxor Asset Management, as they will likely have less correlation to volatile markets than other categories.

Hedge funds became highly correlated to their benchmarks from mid-2011, as European debt problems started to dominate market movements, Lyxor research indicates. It was cited as the main reason for disappointing performance in the sector last year.

Asian hedge fund performance had, on average, a correlation of 0.88 to the MSCI Asia Pacific Index in 2011, according to data provider Eurkeahedge. A figure of 1 indicates direct market correlation. Asian relative value had a correlation figure of 0.64, putting it among the lesser-correlated strategies.

While correlation on a global basis dropped in the first half of this year, it has been rising again in tandem with growing uncertainty in the eurozone.

“The euro crisis is adding risk and uncertainty to financial markets,” which is affecting not only Europe, but resulting “in consequences for Asian markets as well”, says Jeanne Asseraf-Bitton, Lyxor senior strategist.

Long/short equity fund managers have found it difficult to generate returns amid market uncertainty, but Lyxor takes the view that there are investment opportunities in relative arbitrage. The strategy is aimed at generating returns from mispricing between securities or other instruments that normally trade at similar values.

Relative-value funds had the best returns among all strategies in April, according to data provider Eurekahedge. Asia ex-Japan relative-value managers had the highest compared with regional peers, with an average return of 11.34%.

“The challenge right now, at least specifically in Asia, is to market relative value strategies to Asian investors who are looking for more consistent returns than those being delivered in the macro and CTA (commodities trading advisor) space,” says Basil Williams, founder and chief executive of US-based Concordia Advisors, which manages a range of relative-value funds with a total AUM of $1 billion.

The relative-value arbitrage fund category took a reputational hit when US-based Long-Term Capital Management – a pioneer of the strategy – collapsed in 2000 after loading up on illiquid securities. Run by a team that included two Nobel Prize-winning economists, the fund managed $130 billion in assets at its peak in early 1998.

In recent years, however, capital has been seeping back into the strategy, with global AUM for relative-value funds standing at $52.2 billion in AUM at the end of April, compared with $48.6 billion in the same period last year, according to Eurekahedge.

Few relative-value strategies are managed in Asia, where they comprise only 5.2% of the hedge fund sector as at the end of 2011. However, more launches are in the pipeline, including one by William Lee, the former head of JPMorgan’s Asia Pacific equity derivatives group, which is slated to launch later this year.

“There’s a lot of interest in Europe for Asian hedge funds,” says Asseraf-Bitton, given the economic slowdown in the West.  “In a world where growth has become scarce, Asia – which has more favourable long-term fundamentals – looks attractive to many investors.”