Rebound for AUMs among Top 10 Hedge Fund Trends

Hedge fund outflows have been all too common in recent years, as many failed to beat the market. But things are looking up, according to Agecroft Partners, a prominent consulting firm for the industry—and an occasional critic of it.

Institutional investors are coming back to hedge funds, dismayed by fixed income’s paltry yields and in a quest for greater diversification, not to mention better performance, said Don Steinbrugge, the firm’s CEO.

Last year, a turbulent one, was tailor-made for hedge operators, he and others argue. In 2020, there were some remarkable investing coups, most prominently Bill Ackman’s success in the early days of the pandemic, when markets swooned: The Pershing Square chief’s core move was his investing $27 million in credit default swaps, which ballooned to $2.6 billion initially and more later.

Meanwhile, hedge funds as a class finally edged past the S&P 500 last year, research firm Preqin reported. While hedgies like to say people should invest in them for diversification, not market beating, trumping the market was a big plus for the category.

The 10 trends that Agecroft, in a report, sees gathering:

Hedge fund industry AUM reaches record high, due to net inflows. Credit the investment outperformance for this, Steinbrugge wrote. Hedge fund industry assets will reach an all-time high this year, he predicted, and, indeed, Barclayhedge researchers estimate hedge fund assets under management (AUM) jumped 7.6% last year, after several years of dropping or small increases.“The market volatility of 2020 stress-tested the hedge fund industry and, for the most part, fund performance met investor expectations,” Steinbrugge indicated. This situation is drawing fresh attention from institutions, he added.
More hedge fund manager searches. Most search activity was squelched owing to COVID-19, which led to office closings. And the second and third quarters were consumed with hedge executives getting used to remote work. So the industry has a lot of pent-up demand.
Resurrection of long-short equity. This strategy once dominated the industry, and a few years ago it peaked at 40% of assets. Then things went south. “Importantly, the strategy generally showed little evidence that it could consistently add value (alpha) through stock selection that would justify a hedge fund fee structure,” Steinbrugge wrote. Plus, the swelling investor preference for index funds made for stiff competition. But then came the wild ride of 2020, where disparities between asset classes, such as large-caps and small-caps, made for good opportunities.
Greater focus on ESG and diversity. Environmental, social, and governance (ESG) investing is a sweet spot for hedge leaders. ESG investing looks to be reaching a tipping point and will likely gain universal traction among institutional investors, Steinbrugge opined. The quest for racial justice that grew last year added to the momentum.
The line between hedge funds and private equity continues to blur. Over the past decade, private equity firms and hedge funds have increasingly been offering similar strategies with differing fund structures—such as distressed debt, specialty finance, and reinsurance.
Fee compression: 1% and 15% are the new normal. The old level was a 2% annual performance fee and 20% of the profits, but institutional clients balked at that. Especially with these large clients, hedge funds are more open to slicing their own take.
In-person meetings will resume by this year’s fourth quarter. And that will help the smaller players, who have not been able to flog their services as easily on a screen as the big boys with large reputations. The lack of in-person meetings, a critical and oftentimes required step in finalizing an asset allocation, made fundraising disproportionately more difficult for small and mid-sized firms.
Virtual meetings are here to stay. These have proved to be surprisingly efficient, with more senior fund figures able to attend. Plus, they are easily recorded. Agecroft expects a large portion of introductory meetings and early-stage research to continue to be conducted virtually. Later-stage meetings likely will be in person.
Health care institutions will drive growth. The aging US population and medical technology advances are the key factors. So health has become a separate category within hedge fund strategies.
Increased regulatory scrutiny of hedge funds. This isn’t the first time the industry attracted accusations, with the latest being for lowering government bond liquidity in the February-March sell-off. With the new Biden administration taking office, and Janet Yellen as Treasury secretary, “we expect an extensive review of transparency requirements and leverage limits within the hedge fund industry,” Steinbrugge said.