The news for run-of-the-mill hedge funds in a Barclays prime brokerage piece is not entirely positive. The study of 340 hedge fund investors with over $8 trillion in assets noted general dissatisfaction over recent performance. The study highlighted that for the last 4.5 years hedge funds generated negative cumulative alpha which topped in May 2011. Amid losing hedge funds, where allocators expect to pull investments, there are also winners – pointing to an interesting if yet unidentified major trend in investing. But notes liquidations are coming stating:
We expect HF liquidations in 2016 to rise to 12% from a recent historical average of 10%, given the performance challenges of 2015 and early 2016.
Additionally, if 2016 HF performance continues at, or falls below, the annualised 1Q16 / 2H15 levels, the industry may face a reduction in AUM as net new flows are unlikely to be additive.
For the hedge fund industry, size does matter and bigger isn't always better
The Barclays study of institutional investors who represent nearly $7.7 trillion in assets under advisement was pointed in several regards, addressing industry challenges but also pointing to opportunity.
The report addressed the topic of “how big is too big,” pointing to a diminishing return potential once a hedge fund gathers too much in assets. The report shed light on how institutional investors are increasingly viewing their hedge fund allocations from a new perspective.
The study, which included 73 hedge funds of funds, 66 family offices, 39 endowments and foundations, 38 investment consultants, 37 “other investors,” 30 public pension plans, 26 private pension plans, 18 private banks and 13 insurance companies, found that half of those surveyed believed hedge fund investments did not meet their expectations over the last few years.
This does not necessarily mean they are changing allocations, just potentially adjusting their strategy mix, the report said.
Hedge fund performance hit by political and central bank macro factors
While general hedge performance has been additive since 1993, it plateaued in 2011, the report concluded.
Why has this performance downdraft occurred?
Three quarters of institutional investors thought that the hedge fund industry has become too big relative to the limited opportunities available. Separately, an active industry discussion has taken place that debates the concept that large hedge funds cannot move the performance needle by investing in niche markets. This performance gap at a time of significant inflows buttresses that argument to various extents.
While size did matter, 57% of survey respondents attributed drivers of negative performance to be macro in nature, including political and central bank related hurdles.
What is the impact?
The study noted that hedge fund performance has an asset allocation decision lag of one to three quarters. On a net basis, Barclays does not think the hedge fund industry will grow, but it won’t lose net assets either, remaining near $2.9 trillion.
Others are looking for a change in expectations.
One investor interviewed by Barclays said that the environment for hedge funds has dramatically changed due to new regulations, monetary intervention and increased operational burdens. As such, “it might make sense to change the expectations of HFs commensurately,” the report, citing an investor, stated. “While this will not relieve HF managers from the pressure of pushing fees down for instance, it might change the conversation with investors regarding what the objectives / expectations of an allocation should be.”
The Barclays report briefly touched on the notion that in an environment of heavy monetary intervention traditional long only and long / short strategies based on individual stock selection might not work as well.
While overall hedge fund industry assets projected to remain stable, strategy shifting sees a noncorrelated benefit
An interesting trend is in strategy re-allocation decisions. The strategies expected to lose assets are those generally tied to the concept of alpha “beating the stock market.” Equity Long / Short and Event Driven strategies have the lowest level of investor interest on a net basis, a trend that Barclays says stated at the end of 2015.
Those strategies that appear to be gaining the most interest are strategies noncorrelated to the stock market, whose “alpha” comes from independent returns generation.
Systematic CTA strategies lead this parade, up 25% in assets and expected to be in favor over the next six to 12 months along with Quant Equity, which was up 24%. This trend began in 2015 and continues to gain momentum, which Barclays noted:
Overall trends appear to point to investors positioning their portfolios more toward systematic and quant type strategies. In addition to systematic strategies, we expect distressed type managers to attract significant interest for the remainder of the year, which might translate into flows if investment opportunities in the space increase.
Fee compression is also hitting the Systematic CTA strategies at a time of increased demand. Accessing the alternative trend following beta through low cost replication models and “smart beta” products has cut into management fees, the report highlighted, but performance fees remain healthy for those firms that can generate alternative noncorrelated alpha.
Equity Market Neutral, Equity Emerging Markets, Macro, and FIRV strategies are all in favor recently, but this is generally a new trend that did not begin in 2015, the report noted.
“Based on investor input, we expect Systematic / Commodity Trading Advisors (CTA), Quant Equity, Distressed Credit, and Equity Market Neutral strategies to attract investor interest and allocations over the next 6 to 12 months,” the report said.