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Investors and Fund Managers Agree: Performance and Fees Are Key for the Hedge Fund Industry in 2017

by Michael Burke

  • 24 Apr 2017
  • HF

After a disappointing couple of years of hedge funds returns, many investors began reducing their allocations to the asset class in 2016, resulting in a net $110bn of capital withdrawn from the hedge fund industry – concerns around performance and fees were regularly cited as factors behind redemptions. As fund managers look to make 2017 a year to revive investor sentiment towards hedge funds, we use results from the recently released Preqin Investor Outlook: Alternative Assets, H1 2017 and the Preqin Special Report: Hedge Fund Manager Outlook, H1 2017 to look at the areas that investors and fund managers view as the greatest drivers of change in the coming 12 months, and why the level of concern around these areas has increased.

Views on Performance

Despite the Preqin All-Strategies Hedge Fund benchmark returning 7.34% in 2016, the highest annual return since 2013 (+12.47%), the benchmark still underperformed the S&P 500 PR Index over the year (+9.54%). Two-thirds of the 150 investors surveyed by Preqin in December 2016 felt that their performance expectations had not been met in the past 12 months, twice the corresponding proportion in December 2015. The proportion of investors citing performance as a key issue for fund managers to address in the coming 12 months has doubled over the past year, from 35% in December 2015 to 73% in December 2016, a reflection of investors’ increasingly negative sentiment towards the asset class.

The responses from Preqin’s survey of over 270 fund managers present a very similar trend. Over the 12-month period from November 2015 to November 2016, there has been a forty-percentage-point increase in the proportion of managers that see performance as a key driver of change in the 12 months ahead. Despite the improvement in hedge fund performance over the course of 2016, 41% of fund managers reported that their return expectations for the year had not been met. Managers will be hoping the gains made in the first two months of 2017 will continue throughout the coming year as they attempt to meet not only their own return expectations, but those of their investors as well.

Views on Fees

The majority (64%) of investors surveyed also see their demand for more favourable fees as a key driver of change in the coming 12 months, a proportion that has increased by 50 percentage points over the course of the last three investor surveys conducted by Preqin. With an increasing proportion of institutional investors reporting that their interests are not aligned with those of their fund managers (31% in December 2015 and 69% in December 2016), investors see more favourable fees as a way of better aligning these interests, and it seems the pressure put on fund managers to adapt their fee structures in 2016 may continue.

Similarly to investors, the majority (64%) of fund managers surveyed also believe that fee structures will be a key driver of change in 2017, an increase of 36 percentage points from the previous year, a further indication that investor pressure on hedge fund fees could continue. However, perhaps due to this pressure and the asset outflows recorded in the year, 2016 saw the average management fee of funds incepted in the year decrease from 1.57% in 2015 to 1.51% as managers look to launch more attractive funds. Furthermore, while investors clearly see room for improvement in hedge fund fees, 58% of surveyed investors reported that they had seen fund managers change their fee structures in investors’ favour over 2016.

2017 has begun with two months of positive performance, driving the 12-month cumulative return of the Preqin All-Strategies Hedge Fund benchmark to 13.57%, marking one of the highest returning 12-month periods since 2010. Furthermore, 2016 saw the average fees of funds entering the market decrease and several high-profile managers reduce the level of the fees they charge. If these trends continue throughout the coming year, investors may be reporting an improvement in the alignment of interest with their fund managers in Preqin’s December 2017 survey.

For more analysis on investors’ views on hedge fund terms and conditions, as well as how hedge fund managers are responding to investors’ pressure on fees, please see the March issue of Preqin’s Hedge Fund Spotlight.

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