Private Equity vs. Hedge Funds: A Battle of Expectations

Investors had “more ambitious return targets” for private equity than hedge funds, but were under-allocated to the asset class, according to Preqin.

Asset owners turned to private equity for higher absolute returns than to hedge funds—and have been rewarded accordingly, Preqin has found.

According to the data firm, investors’ median target return for private equity ranged between 14% and 15%, higher than 8% to 9% for hedge funds.

“The prospect of high absolute returns was the most commonly cited reason for investing in private equity, followed by diversification and high risk-adjusted returns,” Preqin said.

Investors “put less emphasis on absolute returns” when it came to hedge funds, instead focusing on diversification benefits, low correlation to other asset classes, and reduced portfolio volatility. Preqin found private equity delivering on these expectations and successfully meeting return targets. 

Private equity’s internal rate of return for the three years to June 2015 reached 16.2%. The figure dropped slightly for five-year returns at 15.4% and 10-year returns at 16.1%.

Hedge funds, on the other hand, fell to the lower end of investors’ target range, with Preqin’s all strategies hedge fund benchmark’s annualized three-year returns lingering at 4.5%. Five-year returns were slightly higher at 4.7%, and 10-year returns reached 7.8%. 

Despite disappointing recent performance, investors’ allocations to hedge funds were generally close to their targets—with average current allocations of 13.8% compared to an average target of 14.2%.

Preqin also found a significant number of investors continuing to invest new capital: Nearly three-quarters of investors interviewed for an H1 2016 survey told the firm they planned to maintain or increase their hedge fund allocations over the long term.

In contrast, asset owners were under-allocated to private equity, the report said, with average commitments reaching only 9.8% versus an 10.9% target. This allocation percentage is expected to grow with 94% of surveyed investors planning to maintain or increase their investments.

Preqin HF v. PESource: Preqin Investor Outlook: Alternative Assets H2 2015

Related: Public Pensions Still Hungry for Hedge Funds

By Sage Um