Investors withdrew capital from hedge funds for the fifth consecutive quarter in Q4 2016, even as the industry posted its strongest year of returns since 2013. As shown in Preqin’s recent report Q4 2016 Hedge Fund Asset Flows, the magnitude of these quarterly outflows has consistently increased over this period from $8.9bn in Q4 2015 to $43.1bn in Q4 2016 (see chart below). Full-year net outflows for 2016 totalled $110bn despite the Preqin All-Strategies Hedge Fund benchmark returning 7.33% for the year, compared with 5.05% in 2014 and 2.15% in 2015.
Investor outflows have been encouraged by the relatively low returns in 2014 and 2015 which reduced investors’ confidence in hedge funds. Although hedge fund performance has since begun to improve, investors remain concerned: two-thirds of investors surveyed for the 2017 Preqin Global Hedge Fund Report stated that their performance expectations had not been met in 2016, while only 3% stated that the asset class had exceeded their expectations. This has consequently increased pressure on fund managers to improve performance with investors citing this as the most significant issue facing hedge funds in the upcoming 12 months; 73% of respondents to Preqin’s H1 2017 survey saw performance as one of the key issues in the next 12 months, up from 49% in the H2 2016 survey.
As highlighted in the Q4 2016 Hedge Fund Asset Flows report, strong past performance has a positive correlation with fund managers' ability to attract new capital in future. Investors’ strong emphasis on fund managers’ past track records has allowed some firms to remain successful in attracting capital despite net outflows across the industry as a whole. Nevertheless, the vast majority of the industry has struggled to recover from this fall in confidence from investors, 31% of which are looking to reduce their allocation to hedge funds over the longer term, compared to only 20% that plan to increase it. Hedge funds may need to continue performing strongly for a while longer before investors begin to reassess their plans and inflows to the asset class resume.