Performance Concerns Lead to Challenging Conditions for Hedge Funds and their Investors

by Amy Bensted

  • 04 Sep 2012
  • HF

The last 12 months have been testing times for the hedge fund asset class. Many international economies have demonstrated sparse growth, which, coupled with capital inflows contracting in the second quarter of 2012, has had an adverse impact on fund performance. With this in mind Preqin conducted its annual study of institutional investor outlook on hedge fund performance and satisfaction with the asset class.

Over 2012 there has been a decline in the number of investors that stated that hedge fund returns have met or have exceeded performance expectations. Currently, 47% of the investors which participated in Preqin’s study stated that the hedge funds in their portfolios have fallen short of expectations, compared to 40% in 2011 and 28% in 2010. In light of this, it is perhaps unsurprising that investors’ confidence in the asset class has declined. Only a negligible proportion (1%) of investors interviewed indicated increased confidence in the asset class. The percentage contrasts strongly with the previous study in 2011, when 20% of investors expressed increased confidence in the asset class. Tellingly, nearly one-quarter of investors interviewed in 2012 stated that their confidence in the ability of hedge funds to perform portfolio objectives had declined over the last 12 months. This represents the largest impact on investor confidence in hedge funds since mid-2009, when investors were evaluating the performance of hedge funds in light of poor returns in 2008, the impact of the Madoff fraud, and the fallout caused by the collapse of Lehman Brothers.

The strategy most commonly cited by investors as underperforming over the last 12 months was long/short equity (55% of investors named it as underperforming). More than three times as many investors stated long/short equity as performing poorly in the past year compared to the second most commonly cited strategy – CTA. Considering the level of capital invested in long/short equity funds, this highlights that there is considerable dissatisfaction across many investors on a global scale. Somewhat surprisingly, however, is the fact that there are still a large proportion of investors (around 40%) stating that long/short equity forms part of their current fund searches. Given the large number of funds in market that operate this strategy, and the significant level of diversity between funds in terms of sector, capitalisation and regional exposure, many investors clearly still feel that it is possible to identify successful managers in the long/short equity space.

Some strategies are centred on investment themes that are better suited to take advantage of macro-economic conditions and the heightened levels of financial market volatility. As markets become increasing affected by economic and government-related events, strategies such as global macro have attracted more attention from investors. When asked which particular strategies exceeded expectations, 30% of investors noted that global macro oriented funds have outperformed over the last 12 months.

With the ongoing uncertainty and volatility in many financial markets across the world, performance concerns are unlikely to disappear in the short term, which has led many investors to reassess their plans. One immediate effect of this is that growing numbers of institutional investors are avoiding hedge fund investments in troubled regions, most notably in Europe, due to the impact of the eurozone sovereign debt crisis.

Prior research carried out by Preqin indicated that nearly 40% of investors cite performance concerns as their reason for making portfolio redemptions. Given the fact that investor dissatisfaction with returns is at its highest level, while investor confidence in the asset class has reached 2008 lows, hedge fund managers need to concentrate on rebuilding investor belief in the industry. Increased communication and transparency will go some way to improving investor attitude towards the asset class. However, this will need to be accompanied by stronger returns towards the latter end of this year should managers hope to retain institutional backing.

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