Investors betting on distressed funds

For the third consecutive quarter, investors increased their allocations to hedge funds focused on special situations and distressed securities, even though returns in these areas are still lagging, according to Crain’s Financial Week.

Total assets in event-driven and special situations funds experienced record growth in the second quarter, with total assets increasing by 16.6%, to $390.4 billion, according to data released Monday by Channel Capital Group’s HedgeFund.net.
New allocations accounted for the highest level of growth for these funds since 2004. Total assets in distressed securities funds increased by $23.1 billion in the second quarter, to a total of $275.4 billion.

Overall, hedge fund assets increased 4.4%, to almost $3 trillion, in the second quarter. The increase was due to an estimated $34.1 billion in new allocations by investors and $91.3 billion added thanks to performance gains.

Investors also reduced allocations to equities and increased allocations to fixed-income in the second quarter, according to the Hedgefund.net report.
Funds focusing on mortgage-related fixed-income securities were especially popular, rising 19% to about $35 billion.

“It’s a sign that mortgage-related securities are undervalued,” said Peter Laurelli, vice president of Channel Capital Group.
He added that investors’ interest in fixed-income investments mostly fell into distress investing. “Some people may believe there’s greater value in credit markets.”

Nevertheless, event-driven and distressed strategies haven’t yet provided positive returns so far this year, according to EDHEC Risk and Asset Management Research Centre, which is part of French business school EDHEC.

Returns in distressed securities strategies are down 3.5% so far this year and fell 2% in July, the research center reported.
Event-driven strategies are down 3.6% this year and were off 1.8% in July. Short-selling strategies posted the best return year to date, up 12.8%, while emerging markets strategies posted the greatest decline, losing 8.7% so far this year.