Investors Struggle to Find Attractive Hedge Funds

Unsatisfactory long-term performance is leading to reduced allocations

A new survey of institutional investors in hedge funds finds 42% of investors reporting more difficulty in sourcing attractive funds to invest in last year than in 2015.

The findings were based on a poll of 178 investors polled in June by alternatives data provider Preqin.

Forty-nine percent of respondents said they planned to reduce allocations over the coming year. The survey showed that longer-term performance was a key element in their allocation decisions.

“Hedge fund investors recognize that the performance of the industry has made some progress over the past year, but they still have serious concerns over the returns generated by funds in their portfolios,” Preqin’s head of hedge fund products Amy Bensted said in a statement.

In August, hedge funds recorded a 1% return for the month.

Of those investors in the survey planning to reduce investments, 38% cited the industry’s unsatisfactory three-year performance. Sixteen percent pointed to the negative outlook on future performance, and 13% to high fees.

Forty-eight percent of investors reported that fewer than half of their portfolio hedge funds had met expectations over the past 12 months. Thirteen percent reported that they had constructed portfolios in which all funds met their expectations over that period, but 12% said that all of their holdings had failed to meet their benchmarks.

When selecting new funds, 76% of investors said they looked for a successful team performance track record, while 54% seek proven experience and 51% successful firm-level performance.

However, performance can differ between leading strategies and within them. Preqin said interquartile ranges for annualized three-year returns varied from 5.1% for relative value funds to 7.7% for macro strategy funds.

Likewise, investors reported differing levels of satisfaction when comparing hedge fund strategies. Three-quarters of investors in event-driven and credit strategies said their investments had met expectations over the 12 months to June. In comparison, only 48% of investors were satisfied with returns in macro strategies.

Next 12 Months

Given widespread dissatisfaction with performance, “it is not surprising that underwhelming three-year returns are the foremost reason investors give for reducing allocations,” Bensted said. “This process is likely to involve reallocation or rebalancing, but in this regard investors are faced with a number of significant challenges.”

Bensted noted that the dispersion of returns between different leading hedge fund strategies was wide, and with thousands of funds pursuing each strategy, great variance existed within each one.

“There are now almost 15,000 hedge funds open to investment, far more than can be evaluated individually by institutions, and so building an effective portfolio that meets their needs is becoming an ever-larger task.”

Preqin’s June survey identified 14,779 funds, up from 12,500 in 2012.

Investors’ allocation plans vary accordingly. Following are investor respondents’ allocation plans for the next 12 months from June:

All funds

  • Increase exposure: 20%
  • Maintain exposure: 31%
  • Reduce exposure: 49%

Relative value strategies

  • Increase exposure: 33%
  • Maintain exposure: 67%
  • Reduce exposure: 0%

Macro strategies

  • Increase exposure: 31%
  • Maintain exposure: 62%
  • Reduce exposure: 8%

Equity strategies

  • Increase exposure: 27%
  • Maintain exposure: 60%
  • Reduce exposure: 13%

Event-driven strategies

  • Increase exposure: 24%
  • Maintain exposure: 72%
  • Reduce exposure: 4%

Credit strategies

  • Increase exposure: 17%
  • Maintain exposure: 67%
  • Reduce exposure: 17%

Multi-strategy

  • Increase exposure: 15%
  • Maintain exposure: 73%
  • Reduce exposure: 12%
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