2017 Trends – Continued Outflows From Hedge Funds Look Likely

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In this month’s Hedge Fund Spotlight, we use exclusive fund manager and investor survey results to highlight four trends that are likely to shape 2017:

2016 Hedge Fund Letters

• Continued outflows from hedge funds look likely.
• Overview of the strategies that will see inflows and outflows.
• Performance and fees at the forefront of the industry.
• Improved performance outlook for 2017.

Consistent Top Performing Funds

We provide insight into the hedge funds that have performed most consistently over the past three and five years, across the following strategies: equity, macro, event driven, credit, relative value, CTAs and multi-strategy.

Predictions For 2017

Using the results of Preqin’s surveys of over 270 hedge fund managers and over 150 investors conducted for the  2017 Preqin Global Hedge Fund Report and data from  Hedge Fund Online, we predict four trends that are likely to shape 2017.

Prediction 1: Continued Outflows From Hedge Funds Look Likely

Hedge funds saw net outflows of $110bn in 2016, with more than half (54%) of all funds recording outflows over the year as performance and fee concerns saw some investors pull capital from hedge fund portfolios. Credit and equity strategies recorded the largest net outflows over 2016. CTAs saw the largest inflows ($25.5bn), with no top-level hedge fund strategies recording an inflow in 2016.

Following a difficult 2016, 2017 looks to be another challenging year for fundraising. In our December 2015 interviews with investors we noted that more investors planned to reduce their allocations than increase their exposure, the first time on record (Fig. 1); this was followed by a year of outflows. For the second consecutive year, a greater proportion of investors surveyed by Preqin plan to decrease (38%) their allocation to hedge funds than increase (20%) it. With outflows accelerating over 2016, and more investors planning to reduce their allocations in 2017 than there were in 2016, we may even see larger outflows over the forthcoming year than those recorded in 2016.

Prediction Two: Relative Value Strategies To See Inflows; CTAs Could See Outflows

Although there may be continued outflows from hedge funds as a whole over 2017, Preqin’s December 2016 interviews with investors indicate that some strategies and fund types may have more success in raising capital than others.

Relative value strategies look set to attract the attention of investors in 2017. Over a quarter (26%) of investors with exposure to relative value strategies plan to increase their allocation over the year; in contrast, just 6% expect to reduce their exposure to this strategy. Investors have more of a mixed outlook on macro strategies and equity strategies; however, in both cases, more investors plan to weight in favour of these strategies than to reduce their holdings. At the other end of the scale are CTAs. Twice as many investors in the strategy plan reduce their exposure to managed futures than plan to increase their allocation, and therefore we may see outflows from these funds over 2017. With performance at the forefront of investor concerns, this may be as a result of the underperformance of the strategy in 2017: the Preqin All-Strategies CTA benchmark returned just 0.91% in 2016, and 65% of investors in CTAs reported that these funds had failed to meet expectations over the year.

Of the 276 hedge fund managers surveyed by Preqin in November 2016, 37% plan on launching a new fund in 2017 (Fig. 4). Among these managers, managed futures/CTAs represent 14% of all planned launches, as fund managers look to capitalize on potential further commodity market volatility in 2017. Despite being the most sought-after strategy by investors, relative value strategies launches account for just 5% of planned launches, the smallest proportion among top-level strategies.

Prediction Three: Performance And Fees To Remain Key Issues

Performance and fees drove the narrative in 2016; several of the high-profile investors that made significant redemptions over the year cited these twin issues as the motivation behind their decision. Seventy-three percent and 64% respectively of the fund managers and investors that Preqin interviewed at the end of 2016 believe that performance and fees are the key issues impacting the industry today. Therefore, in 2017 it seems these two concerns remain at the forefront of both investors’ and fund managers’ minds.

Significant levels of investors believe that their interests are not aligned with those of their fund managers. However, the majority (58%) of investors reported that they had seen an improvement in their favour in the terms and conditions charged by their fund managers over the course of 2016. As shown in Fig. 6, management fees have been decreasing over recent years; single-manager funds launched in 2010 charged a mean management fee of 1.65%, whereas in 2016, this was 14 basis points lower at 1.51%. However, although the majority (55%) of investors reported they had seen an improvement in the level of management fees charged by their fund managers in 2016, over three-quarters (76%) want to see further improvements in this area over 2017.

Prediction Four: Performance May Continue To Improve

The Preqin All-Strategies Hedge Fund benchmark posted nine months of positive returns in 2016, generating 7.40% over the course of the year, the highest annual return for three years and more than three times the 2.03% returned in 2015. Of the six top-level hedge fund strategies, relative value strategies was the only strategy not to generate a higher annual return than in 2015, posting 4.74% in 2016 compared to 5.65% (Fig. 7).

Despite this improvement, significant levels of investors reported to Preqin that their portfolios had failed to meet expectations in 2016 (Fig. 8). Two-thirds of investors interviewed by Preqin in December 2016 reported that the performance of their hedge fund portfolios had fallen short of expectations over the course of the year, twice the level recorded at the end of 2015 and the highest level seen in any of Preqin’s end-of-year investor surveys.

While investors have expressed concerns with the performance of hedge funds in recent years, they expect the industry will continue to perform better in 2017: over a quarter (28%) of investors believe hedge fund returns will improve in 2017, compared to 19% predicting the benchmark return will be lower. Hedge fund managers also expressed increased confidence in their ability to generate stronger returns in 2017: nearly half (47%) of managers surveyed in November 2016 believe the Preqin All-Strategies Hedge Fund benchmark will be higher in 2017 than in 2016 (+7.40%), compared with just 11% that believe the benchmark will fall short of this return.

Most Consistent Top Performing Hedge Funds

We provide an overview of the most consistent performing hedge funds over three and fi ve years using data from  Hedge Fund Online.

Methodology

These funds were determined as most consistent using a percentile rank methodology, whereby each of the four metrics – annualized return, annualized volatility, Sharpe ratio and Sortino ratio – were representatively graded in a universe of hedge funds with matching strategy criteria and performance data up to December 2016 on Preqin’s Hedge Fund Online database over two sample periods. The ‘average score’ of each fund was then derived through an average of the four percentile values and solely used to determine fund consistency. Where a Sortino ratio could not be calculated due to the fund not generating a negative return in the sample period, the fund was given a percentile score of 100 for its Sortino ratio metric.

Equity Strategies Funds

Macro Strategies Funds

Event Driven Strategies Funds

Credit Strategies Funds

Relative Value Strategies Funds

CTAs

Multi-Strategy Funds

See the full PDF below.