Following poor performance in late 2015 and early 2016, hedge fund industry news has generally been negative. Despite significant improvements over Q2 and Q3, investor sentiment has been difficult to change. Nearly all of the $71.4bn gained in assets in 2015 have been wiped out, with reported outflows of $66.7bn thus far in 2016 (please see Q3 2016 Hedge Fund Asset Flows for more information). Furthermore, Preqin’s latest Investor Outlook showed that 39% of investors interviewed in June 2016 planned to reduce their hedge fund allocation in the next 12 months, while just 18% of investors planned to increase their allocation to the asset class. Fees, transparency and low returns were investors’ key concerns.
Heightened concerns have resulted in a change of investment strategy for many investors throughout the year. For some, it meant the redemption of entire hedge fund portfolios: in early Q2, New York City Employees’ Retirement System announced that it would redeem its $1.4bn hedge fund portfolio due to high fees, poor performance and high risk levels. Similarly, in Q3, Kentucky Retirement Systems drew up a plan to redeem its entire portfolio by 2019, also citing lacklustre performance.
Despite this, most investors did not exit the asset class altogether; the majority of investors that sought changes to their investment strategy chose to reduce their allocation to hedge funds. Two of the largest redemptions were made by AIG and MetLife Insurance Company, which made the decision to redeem $4bn and $1.2bn respectively, while New Jersey State Investment Council, Illinois State Board of Investment and Employees’ Retirement System of Rhode Island cut their target allocations to hedge funds by 50% or more.
Some investors were more creative in their response. For example, Alaska Permanent Fund Corporation decided to exit all of its fund of hedge fund investments in Q2 and create an in-house team to select hedge funds, eliminating the extra layer of manager fees. Another recent trend in the industry is consolidation: investors are decreasing the amount of funds in their portfolios and re-allocating capital to top performing managers, with hopes to reduce fees and increase returns.
At the beginning of H2 2016, investors reported that their main concerns were high fees and poor performance. However, the asset class has shown its resilience and by the end of Q3 2016, hedge funds had posted seven consecutive months of positive returns for the Preqin All-Strategies Hedge Fund benchmark. Furthermore, 73% of hedge fund investors interviewed reported to be seeking improvements to management fees in the next 12 months. If investor and manager interests can become more aligned, and positive returns continue, the hedge fund industry is likely to attract new investment and recoup the assets lost over 2016.