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
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
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
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
"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
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
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
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.