Hedge Fund Assets Rise to Record as Risk Appetite Returns

Hedge Fund Research (HFR) put out its quarterly report on assets. The data show that total investor capital allocated to hedge funds in Q1 2012 exceeded $16 billion. Because of this:

[T]otal capital invested in the global hedge fund industry increased to $2.13 trillion, surpassing the previous record of $2.04 trillion set at mid-year 2011.

Hardly anyone would argue that hedge funds tend to take more risks with capital than mutual funds or the typical cash-rich corporation or individual does. Many of the nation’s largest pension funds cut back on risk when they were hit by the market downturn in 2008. Well-known endowments, like those among Harvard and other Ivy League schools, lost as much as 25% of their assets. Risk went out of style.

The observation that risk has become a greater part of many investments has been made time and again this year. The stock market has soared at a particularly rapid pace recently. The poster child for equity risk is Apple (NASDAQ: AAPL), with its shares up almost 50% this year while the S&P 500 is only 10% higher. How can the stock of a company that already has risen at a searing pace for 10 years continue to keep such a stride? That answer, many analysts believe, is to forget past performance. Apple will rise 50% again, and soon.

The risk in equity investments is not alone. A writer at Barron’s reported at the end of March that:

Readers of this blog are well aware of how in vogue junk bonds have been. Last week marked the 17th straight week of inflows for junk bond mutual funds and ETFs.

The signs that risk has come back into vogue among investors have become more prevalent as 2012 has passed. And, the risks are real. Corporate earnings are expected to be modest at best for the first quarter. Recent data show that housing and employment trends are still often negative. If the trend of these data remain as they are, support for riskier investment will disappear.

The investment markets are good until they are not. That is the trap when money is “put to work.” Returns chase better returns. Investors read about the most successful hedge funds and their bosses who make hundreds of millions or billions of dollars and want to be equally successful. But hedge fund balances were savaged just four years ago. That already has been forgotten.

Douglas A. McIntyre