Neil A. O’Hara, author and journalist, writes about financial topics including hedge funds, trading and securities services for a professional and mainstream audience. Mr. O’Hara is the author of record for the 6th Edition of “The Fundamentals of Municipal Bonds” (John Wiley & Sons, 2011).
Hedge funds took a hit during the financial crisis—along with everything else—yet many were quick to bounce back. Industry assets under management now total $2.5trn, up from $1.5trn five years ago, growth that has come despite mediocre performance relative to market benchmarks in recent years. The institutional investors that plough money into hedge funds take the long view and expect them to outperform bear markets (as they did in 2008/2009), not bull runs. Are expectations out of whack with reality?
The widely expected Federal Reserve move to taper its monthly bond purchases foreshadows higher Treasury interest rates, a big red flag for most fixed income investments. Even so, it is likely that short-term rates probably won’t tick up until 2015. US treasuries, a risk-free pure play on rates, are the most vulnerable, while the credit spread in investment grade corporate bonds will cushion the blow. For high yield bonds, credit quality is the principal risk— literally and figuratively—so provided Fed tightening reflects a stronger economy corporate cash flow will be robust and default rates should remain low. In fact, high yield could be the 2014 star performer in fixed income.
Collateralised loan obligations (CLOs) were among the first segments of the securitisation market to bounce back after the financial crisis. Prices tanked in late 2008 and early 2009 when investors feared the recession would push up corporate default rates—but the concerns proved overblown. Although returns on CLO equity varied by manager, the credit support mechanisms built into the structure kept even the worst deals current on their debt capital. Robust performance resuscitated investor interest in CLOs, but regulators could stall the revival.