On the face of it, the hedge fund industry is seemingly healthy, despite several years of underperformance. Year-end assets rose to a record $2.602 trillion, according to industry tracker eVestment.
Beneath the headline news, however, there are some troubling signs that investors in hedge funds are starting to become uneasy with the mediocre returns being posted by many funds.
According to eVestment’s latest report, released February 1, total industry assets as of the last quarter climbed just 0.6 percent. It attributed this increase primarily to performance gains. But in fact, investors yanked a net $10.5 billion from hedge funds in the December three-month period. In four of the past six quarters, investors pulled more money out of hedge funds than they put into them.
The report does not shed light on the net outflows, but it’s a widely known fact that many investors are unhappy about paying huge fees, even as the average hedge fund has significantly underperformed major market indices for at least three consecutive years now.
According to a second survey, published by Preqin on January 31, only 3 percent of investors in hedge funds said their hedge fund returns have exceeded expectations, compared with 11 percent in the prior year’s survey. Another 41 percent said returns have fallen short of expectations, and about the same percentage said the same last year.
“Disappointment with performance is at its highest level since Preqin began collecting this data in 2008,” says the London research firm specializing in alternative investments. The survey is based on in-depth interviews conducted in December with 85 investors and 60 hedge fund managers worldwide.
This column pointed out in December that several investors were already cutting back on their hedge fund portfolios.
For one, Tom Nicholson, CEO of Mintz Group, a family office controlled by Saul Mintz, who made a big portion of his fortune in the plastics business, said in an interview he was selling some hedge funds because he is disappointed with the returns over the past three years or so. At the time he explained he was making fairly significant changes at the end of the year, in part to settle the estate following Saul Mintz’s death in September.
“The combination of the two led us to pull back very significantly on our hedge fund portfolio,” he said.
Nicholson, however, stressed he is not anti-hedge fund. Rather, he’d like to see funds earn their hefty fees by adding value.
For another, the Public Employees Retirement Association of New Mexico has reduced its long-term allocation to hedge funds from 9 percent to 7 percent of total assets. Jason Goeller, investment officer for hedge funds, said at the time the decision was in part, intended to make room for an allocation for what the Retirement Association is calling a Liquid Alpha Bucket, the result of a broad asset allocation study in August and an accompanying long-only study.
Another factor behind the disenchantment with hedge funds is an apparent a disconnect between the limited partners in hedge funds and the general partners with whom they invest. Asked whether they are positive, negative or neutral in their outlook towards the hedge fund industry in 2013, just 36 percent of LPs said they have a positive attitude versus 55 percent of the GPs.
More interesting, 44 percent of GPs have an outright negative view compared with just 18 percent of LPs, while 44 percent of investors have a neutral attitude.
GPs said they’re increasingly frustrated over new regulations that have gone into effect, with 42 percent saying regulations will negatively impact the industry. They’re especially concerned about the Dodd-Frank Act requirement that most hedge funds register with the Securities and Exchange Commission, a process they’ve said adds burdensome and costly compliance procedures.
Preqin reports that while 49 percent of LPs believe regulations are a good thing for the hedge fund industry overall, about a third believes that regulation will have negative repercussions.Their worry is that the increased compliance costs will in turn be passed on to investors.
Moreover, the newer, more nimble fund managers, many of whom have managed to outperform their more seasoned peers, based on some studies, may be particularly vulnerable to increased compliance costs. Preqin reports that those LPs favoring the emerging fund managers fear that regulations could prove too onerous and drive the upstarts out of business.
Yet another reason for investors to remain cautious with hedge funds unless, of course, the industry manages to score big gains and turn in a blockbuster performance in 2013.