A few years ago, investors were happy to pay 2% a year, plus a 20% performance fee for access to the top talent in the hedge fund industry. Today, the sector is bleeding assets as investors look at fees and performance and conclude that the two don’t make a compelling case. Is the sector in terminal decline?
- Investors are pulling billions from hedge funds on fee and performance problems
- Hedge funds increasingly look like a poorly performing, expensive equity mutual fund
- The sector needs to reform to capture demand for alternative assets
The latest report from eVestment research showed investors pulled $14.9bn from hedge funds in the first quarter of 2019, $13.7bn in March alone. This is the fourth consecutive quarter of outflows.
The problem, it seems, is performance. The global hedge fund industry delivered losses of 5.1% in 2018, putting it behind the S&P fall of 4.4%. This is the worst of all possible worlds. Not only do hedge funds appear to have been correlated to the S&P, but actively did worse. If all hedge funds are little better than an expensive, poorly-performing equity fund, why would anyone hold them?
Certainly, the sector has cancelled some of its losses this year, with a 5.34% return for the hedge fund aggregate index, but the S&P has returned more than double.
Part of the problem, is appears, is that at a time of buoyant markets, many hedge funds have upped their long books to improve performance. However, this has edged them away from their role as diversifiers and ‘pure alpha’ plays. Many investors have realised this and it is no surprise that the long/short equity sector has been one of the hardest hit and seen significant outflows.
However, it is fees that have really started to hurt. Investors have grown wise the hedge fund ‘trick’ of taking a huge bets on the market, which – when they go right – earn a vast performance fee, but when they go wrong, the manager still gets their 2%. Hedge fund fees have come down, but not meaningfully. In a low growth world, a hedge fund manager has to be doing something really special to justify a 2% performance fee and many aren’t.
It is also possible that the conventional investment sector has cannibalised some of the hedge fund universe. Whereas talented managers would, at one point, leave to join hedge funds, they can now run long/short equity funds or similar in the comfort of an established fund group.
In theory, investors may need the hedge fund sector more than ever. If equity and bond markets turn lower, uncorrelated sources of return are likely to become increasingly important. However, canny investors may look outside the hedge fund sector unless they see stronger performance and more competitive fees.
