The following is a guest blog post:
Hedge funds disappointed investors in 2016 when they posted lower than expected returns. Three out of four investors revealed that they were disappointed with the returns on their investments in 2016. In 2015, only two-third of investors reported such disappointment with the returns on their investments.
Of course, hedge funds disappointed investors in 2016 when they posted returns of 5.6%. In contrast, the S&P 500 posted gains of 11% and gold investors recorded gains of 8.10% in FY2016. In essence, investors would have been better served if they had placed their money in stocks or gold. This piece seeks to explore some of the reasons behind the weakness in the performance of hedge funds last year.
Why did hedge funds under perform in 2016
Many different factors could have been responsible for the dismal performance of hedge funds in 2016. Some fund managers may simply not be good at their jobs – they could have made some not-so-smart investment/trading decisions. The market also developed a mind of its own to reward bullish investors even though the shocking Brexit vote and Donald’s Trump surprise victory should have triggered uncertainty in the market.
Nonetheless, the main reason behind the broad-based under-performance among hedge funds in 2016 was the fact that the market is becoming overcrowded. Henry Wasserman a trader at Lionexo binary options observes that “the fact that there are more than 10,000 hedge fund managers chasing the same opportunities means there’s less room for them to generate an Alpha”. Many sectors of the economy such as technology and utilities are recording massive gains; hence, there is little room for fund managers to short stocks. Now, money managers must all look for trading opportunities to profit under the same narrow macroeconomic situations.
What does 2017 hold for hedge funds?
Hedge funds suffered a massive blow in 2016— investors had pulled out about $70B from funds by the end of the year. The outflow of $70B recorded marks the largest outflow of funds since 2009. The fact that hedge funds had a poor performance coupled with the massive outflow of investors’ funds suggests that they’ll will be taking the backseat among other asset classes in 2017.
However, a JPMorgan survey of 234 institutions that have large exposure to hedge funds suggest that 90% of large investors are set to maintain or increase their exposure in funds this year. In addition, institutional investors are set to retain investments in hedge funds despite the fact that they are not expecting outsized returns this year. The survey shows that about 65% of large investors expect annualized returns less than 10%. In contrast, only about 19% of those investors expect fund managers to deliver annualized returns above 10%.
Nonetheless, investors won’t remain loyal to hedge funds blindly if they can’t see decent return on their investments. The JPMorgan survey also showed that 75% of investors are planning to reallocate their investments to three or four new managers.
More so, about 49% of the investors are warming up to the idea of trying out new investment strategies with hedge funds. JPMorgan observes that “high conviction managers that are differentiated and uncorrelated” might see increased inflow of funds from investors this year.