Research highlights weak first quarter for hedge funds

Hedge funds have suffered further redemptions amid weak performance, with Preqin recording net outflows of $14.3 billion in the first quarter of 2016.

By Editorial
Hedge funds have suffered further redemptions amid weak performance, with Preqin recording net outflows of $14.3 billion in the first quarter of 2016.

This comes following $8.9 billion of outflows in the last quarter of 2014 and stands in marked contrast to the $28.8 billion that the industry gained in investor capital during the same period last year. Hedge Fund Research, a Chicago-based data provider, agreed with Preqin, stating that $15.1 billion exited the asset class during the first quarter of 2016, making it the worst quarterly outflow since 2009 during the aftermath of the financial crisis. It also marked the first consecutive quarters of outflows since 2009.

Investor risk tolerance has fallen and a number of allocators have grown impatient with continued underperformance. A survey of investors by Preqin in November 2015 found more investors (32%) intended to reduce their hedge fund exposure in 2016 than increase it (25%). This is the first time Preqin has recorded such a figure. This comes as performance has disappointed. Hedge Fund Research found the average manager has lost 0.67% year-to-date 2016, and 3.9% over the preceding twelve months.

Figures from analysts at J.P. Morgan also make for depressing reading at hedge funds. Analysts estimate that 2016 outflows from hedge funds could reach $25 billion. The report said much of this would be driven by sovereign wealth funds (SWFs) withdrawing from fund managers. Many SWFs have been hit by falling oil prices, which has squeezed government budgets. As such, SWFs are being forced to plug holes in government budgets.

There have also been a handful of high-profile pension fund withdrawals from hedge funds. The New York City Employees’ Retirement System culled its $1.5 billion hedge fund programme citing complaints over the high fee model – the traditional 2% management fee and 20% performance fee. Other major pension schemes to withdraw include CALPERS, the Californian pension fund giant, and PFZW, the Dutch retirement scheme. Nonetheless, these pension schemes tend to be the exception rather than the norm.

Despite the lacklustre performance, fees have remained high. Analysis by Seward & Kissel, a US law firm, found hedge funds were charging between 1.5% and 2% management fees, while performance fees stood still at 20%. Some investors are pushing for change. Whether this will translate into action is open to debate.

Some believe the problem has been compounded because hedge funds have become institutional. There is countless academic research highlighting that smaller managers outperform their larger peers. London’s Cass Business School found a hedge fund with £200 million outperformed a £5 billion manager by 125 basis points (bps) between 1994 and 2014.

This is because smaller managers can invest in niche markets and move nimbly in and out of positions. This has led some to call for pensions to invest into smaller managers. While a handful of pensions do have emerging manager programmes, most schemes write sizeable tickets and are subject to stringent risk concentration criteria. A pension fund cannot “own” a fund per say.

But smaller managers are under pressure too. Many will be disproportionately impacted by the cost of regulation and operational requirements. Others are being squeezed for higher fees by their prime brokers as they are viewed as a balance sheet cost. Those hedge funds are the lucky ones. A number of been unceremoniously exited by their prime brokers arbitrarily. Being exited by a prime broker is seen by investors as a lack of confidence in that manager’s future success.

«