In 2019, recent U.S. tax law changes will focus investors’ attention as never before on hedge fund expenses. Boldface hedge fund managers, faced with intense competition, will have to reinvent themselves if they hope to stay in the game. And Asia, hit with market declines in 2018 and reduced demand for managers focused on the region, will reverse the trend over the coming decade.
These are among the predictions of Don Steinbrugge, head of Agecroft Partners, a third-party marketing firm that specializes in alternative investments with a particular focus on hedge funds. He has tapped the insights of more than 2,000 institutional investors and hundreds of hedge fund organizations for what to expect in the coming year.
Following are Steinbrugge’s predictions for the biggest trends in the hedge fund industry in 2019.
1. Hedge Fund Industry Reaches Maturity
Steinbrugge sees good news for the hedge fund industry in the fact that there have been few wholesale departures by investors. At the same time, he expects very slow growth as the industry approaches a saturation point with more than $3 trillion in assets under management, having reached peak levels in each of the past nine years. Performance has accounted for much of this growth in recent years, with only a modest amount of new capital coming into the space. Most hedge fund investors still believe they can achieve diversification benefits from investing in hedge funds, which can also enhance the overall returns of a diversified portfolio.
“Although we expect industry assets to remain fairly stable, we anticipate instability at the strategy and manager level; most new assets invested in hedge fund managers are reallocations of capital redeemed from other managers,” Steinbrugge writes.
2. Continued Broadening of the Definition of ‘Hedge Fund’
The narrow definition of a “hedge fund” as an evergreen fund structure that charges a performance fee has expanded to include the broader offerings of an investment firm with traditional hedge fund expertise, according to Steinbrugge. As the market has reached a saturation point with institutional investors representing a majority of assets, large hedge fund organizations have evolved their business strategy, broadening the target markets from which they seek to raise assets, and offering fund structures and strategies that best align with those investors’ interests.
When reporting their assets, many firms today include both the assets of their traditional hedge fund structures and those in separately managed accounts, co-investments, UCITS, private equity funds, flat fee commingled vehicles and ’40 Act funds. The biggest industry groups are evolving their businesses into broader alternative investment strategies and structures, eventually resulting in a blurring of the lines between alternative investments and traditional asset management firms.
3. Shift From Maximizing Returns to Protecting Capital
From the 2016 fourth quarter through January 2018, investor interest was heavily weighted toward strategies that had the potential to generate the highest returns. February’s spike in volatility gave investors pause, prompting them to rethink their allocations to various hedge fund strategies. The continued rise of U.S. interest rates, trade war tensions and the fourth-quarter selloff in the equity markets has shifted some investors’ focus from maximizing returns to protecting capital.
“We expect to see outflows from strategies with large exposures to market beta, and increased demand for strategies not highly correlated to the capital markets,” Steinbrugge writes.
4. Structural Changes Within the Long/Short Equity Sector
The shift to risk-off mode will cause assets to flow out of the long/short equity sector, which has typically represented about a third of the industry. Funds with long net exposures will likely see outflows, according to Steinbrugge. Particularly hard hit will be funds that focus primarily on large-cap stocks in developed markets. Many investors believe that the large-cap equity market has become so efficiently priced that it is difficult to gain an information advantage.
Areas within long/short equity that should see an increase in demand are those that focus on small- and mid-cap stocks that are less followed by Wall Street, companies based in Asia and sector specialists, such as those that focus on technology or health care.