Investors Sticking with Hedge Funds After Disappointing Year

Hedge funds largely fell short of investor performance targets last year — even as allocators scaled back return expectations.

Two-thirds of investors surveyed by J.P. Morgan said they set a return target of below 10 percent for their hedge fund portfolios in 2016, an increase from the 46 percent who did so in 2014. Yet returns continued to disappoint, with three-quarters of respondents reporting that hedge funds did not meet their return targets last year, up from two-thirds in 2015.

The latest edition of the annual survey collected responses from 234 institutional investors — including pensions, endowments, and funds-of-funds — who invest a combined $750 billion in hedge funds. The survey found that disappointing performance remained the primary cause of hedge fund redemptions.

Of investors surveyed, 80 percent withdrew from at least one hedge fund in 2016. Three-quarters of these respondents cited performance as the reason, while just over half wanted to reduce their exposure to a particular strategy.

Hedge funds as an industry earned 5.57 percent in 2016, according to the HFRI Fund Weighted Composite Index. The Standard & Poor’s 500 stock index, by comparison, gained 11.23 percent.

Roughly a third of investors attributed the low returns to crowding — specifically, too many managers chasing the same limited trading opportunities. Just under a quarter said underperformance was likely the result of macroeconomic factors.

Still, 67 percent of investors said they planned to maintain their allocation to hedge funds in 2017, while an additional 20 percent intended to invest more in the asset category. Three-quarters said they would reallocate to different managers, while roughly half planned to switch up the strategies they invested in. Global macro, distressed credit, and fundamental long-short equity were chosen as the top three strategies most likely to outperform this year. Across the board, investors said they expected fees to decrease in 2017, with 90 percent of respondents anticipating lower fees — up from 60 percent in 2016 and 2015. Over the course of last year, 40 percent of investors said they had negotiated fee rates with hedge fund managers.

Few still paid the traditional 2-and-20, with 94 percent of respondents paying an average management fee of below 2 percent. More than 80 percent said their performance fees averaged below 20 percent.

In addition, 57 percent of respondents predicted higher implementation of hurdle rates by hedge fund managers in 2017, while 40 percent expected improvements in transparency.