Future of Alternatives 2025: Hedge Fund Industry Growth Will Be Reduced by Outflows to 2025

Hedge fund AUM is forecast to increase 19.6% from 2020 to 2025, at a CAGR of 3.6%, but performance-driven growth will be diluted by investor outflows

We expect hedge funds to hold onto their position as the second-largest alternative asset class in 2025, despite relatively weak growth in assets under management (AUM) due to continued outflows. AUM growth will be the lowest of all asset classes at a CAGR of 3.6% per year. Preqin forecasts AUM to reach $4.28tn in 2025, up 19.6% from $3.58tn at the end of 2020 (Fig. 1).

Our prediction is that hedge funds will lose out to passive exchange-traded funds (ETFs), smart beta, and other liquid alternatives that offer risk-adjusted returns at lower cost. We expect AUM to be boosted by performance, with hedge fund returns beating the AUM growth rate over the next five years. The Preqin All-Strategies Hedge Fund Benchmark posted an average yearly return of +6.27% from 2015 to 2019. 

Increasing investor appetite for liquid alternatives – which include ETFs, UCITS, and alternative mutual funds – has come at the expense of hedge funds. Since these options provide inexpensive returns with high liquidity, this trend should continue. Most liquid funds offer daily liquidity and fees below 1%, compared to the typical 2/20 and longer lock-ups for hedge funds. In addition, liquid alternative products offer more customized solutions for investors, with different products geared toward obtaining alpha and beta.

Active Managers Will Continue to Perform Well in Volatility
Hedge funds have the potential to shine in a period with higher-than-average volatility, which has so far defined 2020. The next five years look likely to pose more economic and financial market risks than the past decade. The COVID-19 crisis has necessitated changes that will increase market volatility for years, such as increased debt loads of companies, central banks, and countries, while political risks also lie ahead as countries rethink trade policy and secularization. Hedge funds can exploit the resulting volatility for gain. Active management can work well in periods of uncertainty, proactively governing risk and drawdowns as demonstrated through Calmar ratios during H1 2020.

We expect macro and equity strategies to remain the largest strategies in terms of AUM. Fig. 2 shows that long/short equity and macro funds together make up over a third of core strategies targeted by investors in the next 12 months. There is a good chance that trigger events will take place at an increasing pace in the next five years, increasing the opportunities for macro funds to trade. Equity market neutral strategies may also become more prominent, as investors that remain invested in the asset class choose to do so for absolute returns, rather than alpha or beta which can be obtained from liquid alternatives.

Although a relatively small component of the hedge fund universe, cryptocurrency and related digital asset infrastructure hedge funds doubled in AUM between 2018 and 2019, according to a PwC and Elwood survey, and are expected to do the same by end of 2020. Preqin data shows total AUM in the segment reached $6.6bn as of October 2020, driven by returns. We expect existing hedge fund strategies to augment investment operations with cryptocurrency trading, following the lead of macro and quant strategies which were early adopters. 

Hedge Funds Will Open up to Retail Investors
The regulatory landscape is becoming more favorable to allowing retail investor inflows to the asset class. The SEC recently expanded its definition of an accredited investor, which could be the first step toward retail participation in the asset class. 

However, the industry may resist calls for greater transparency that would accompany increased retail investment. For example, the SEC has proposed dropping the 13-F filing requirement, which governs disclosure of equity holdings, for funds with AUM of less than $3.5bn. The proposal would reduce unnecessary burdens on small investment managers, according to SEC Chairman Jay Clayton. Regardless of such changes, institutional investors will continue to control the vast majority of AUM.

The hedge fund industry’s relationship with the public, and the media in particular, is a rocky one, with public perception widely negative. But this has not stopped industry AUM increasing. Hedge funds proved their risk mitigation strategies through the pandemic-induced market crash this year, reminding investors why hedging is valuable. 

Download a data pack containing all the charts in our asset class forecast articles for Future of Alternatives 2025. For more predictions and projections from Preqin on the future of the alternatives industry, visit our Future of Alternatives 2025 Content Hub.