Buoyed by a strong equity-market rally, hedge funds performed well during the past quarter, according to the Brighton House Q3 report. Investors gravitated towards event-driven hedge funds throughout the third quarter, 2009, primarily in the merger/risk arbitrage and distressed fixed-income areas.

Brighton House Associates (BHA) is an alternative investment research firm that speaks to investors across the globe about their current interest and activity in alternative investment funds.  Brighton House works with a network of over 100 fund managers and assists in indentifying qualified investors for their internal marketing campaigns.

Global Equity

The rebound in global equity markets during the first three quarters, along with successful capital-raising campaigns by large financial institutions, created a favorable environment for catalyst events. The announcements of acquisitions by well-known companies such as Xerox, Walt Disney, and Kraft Foods are only a few examples of the flurry of corporate activity that took place in a variety of sectors during the third quarter.

Dealogic reported that banks and financial institutions sold more than $11 billion in non-government guaranteed bonds in September alone, an increase of more than $6 billion over August.

A senior investment analyst at a southern U.S. university with approximately 30 percent of its endowment dedicated to alternative investments expressed substantial interest in distressed corporate credit and senior bank loans.

As the year winds down and markets continue to stabilize, BHA expects event-driven strategies to present considerable options for attractive returns. York Capital Management, for example, a New York-based firm with over $9 billion under management, recently partnered with Bank of America Merrill Lynch and launched a UCITS III-compliant event-driven fund. Capitalizing on market conditions, the fund has reportedly raised $100 million in assets.3 Furthermore, M&A activity is poised for a flurry of activity particularly in the biotechnology and pharmaceutical sectors.

Long/short equity hedge funds steadily gained momentum in the third quarter, continuing a trend that began in the second quarter.

Funds of hedge funds

Many investors turned to funds of funds during this quarter for the same reasons they invested before the economic downturn: superior manager selection, enhanced risk management, diversification, and consistent returns. Funds that offered these benefits attracted investor attention.

Although some investors mentioned interest in single-strategy funds of funds—the most popular being CTA/managed futures, credit, distressed debt, global macro, and long/short equity—81 percent of investors were focused on multi-strategy funds of funds.

During the last six to eight weeks of the quarter, many funds of funds reported that investors were becoming more serious and detailed in their research. This is a key indicator that commitments are beginning to flow back into the industry. BHA sees this as another sign that funds of funds will continue their rebound.

BHA saw a steady increase in demand for technology-focused funds among private equity investors. During the third quarter, the percentage of investors looking for technology-focused funds in the private equity space increased 11.2 percent. Year to date, the technology sector has been popular with approximately 18 percent of investors researching private equity funds.

Hedge fund investors also expressed increased interest in the technology sector. In the first quarter of 2009, of the top five sectors, the technology sector garnered 20.1 percent of overall market share in the hedge fund space.

During the second quarter, this percentage increased slightly. These numbers indicate that hedge funds increased the amount of capital allocated to technology-related opportunities. Separately, of the hedge fund investors BHA analysts interviewed in the third quarter, the percentage that were looking for technology-focused funds rose to 11 percent.

Both in the hedge fund and in the private equity fund space, increased interest in the technology sector is largely due to industry consolidation and company restructurings, both of which help to eliminate inefficiencies and increase profit margins, leading to solid returns for managers and investors.

Private Equity Funds

During the third quarter, investor interest in private equity funds remained strong and originated from a wide array of different investors. Although funds of private equity funds are statistically the forerunner in the search for private equity funds, BHA’s data suggest that this quarter’s interest came from an even broader source of investors.

Wealth advisors, government pension plans, family offices, and insurance companies all showed considerable interest in speaking with private equity fund managers.

Funds of private equity funds showed the most interest in single-manager private equity funds.

One reason for this diversified interest is that investors from across the globe were, once again, beginning to express interest in capitalizing on opportunities that have emerged in the wake of the financial crisis.

Summary

The continued thaw of credit markets and the resurgence of equity markets led to a sense of optimism in the alternative investment community during the third quarter. Investors reassessed their portfolios and found opportunities abounding in hedge funds and private equity and real estate space. Investors looked to capitalize on distressed situations through event-driven and merger/risk arbitrage hedge funds, they recognized the significant growth potential of the early stage private equity space, and they targeted emerging market real estate investments that could be poised to rebound over the next several years.

Investors took the time to reevaluate their positions, and focused on making strategic allocations to address specific shortcomings or potential opportunities, such as the ones that they found in the technology sector. Institutional investors sought to make savvy investments that do more than satisfy a percentage of a diversified portfolio. They looked for specific fund managers that have an expertise and a track record of success.

If these statistics are an indication of future trends in the alternative industry than BHA expects the optimism that has driven the equity markets back up to continue to ripple into the alternative investment space. BHA data suggests that the strategies and sectors that are poised for explosive growth in the event of an economic recovery will continue to be the focus of alternative investors throughout the remainder of 2009.

Full report can be requested from Brighton House Associates.

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