Hedge fund managers have been put on notice: evolve, deliver or die.
Unless managers produce alpha, diversify institutional portfolios and protect their downside at a fair price, they risk more of the crippling outflows many experienced in 2016.
Industry bifurcation is inevitable, sources said. Likely survivors will be among the cadre of multibillion-dollar firms cushioned by healthy asset levels and good performance, and skilled niche managers whose chosen strategies often are capacity constrained, precluding management of big capital pools.
Between the largest and specialist niche managers, numerous midtier managers will be under immense pressure from institutional investor demands for lower fees, an ongoing low-yield environment and increasing complexity of business operations, pushing many out of business by the end of the decade, according to a new report from The Boston Consulting Group.
“It's a question of the value proposition of hedge funds. If managers are charging 2% and 20% and aren't producing returns, the jig is up,” said Brent Beardsley, managing director and senior partner based in BCG's New York office.
The impact of net negative flows and performance is already evident in the havoc wreaked on the assets of many hedge fund managers tracked by Pensions & Investments for the year ended June 30, 2016, according to annual survey data.
The majority — 70% — of the 99 hedge fund firms that returned P&I's survey in 2016 saw assets decline from the prior year. Of those managers, 40% experienced losses of 10% or more and 27% had declines greater than 20%.
The percentage with asset growth for the year ended June 30 was 28%; 14% saw AUM growth of 10% or more. For 2% of managers, assets were flat in 2016, survey data showed.
The story was different for the prior year — 73% had higher assets in 2015 than in 2014 and 27% saw declines. The universe for that year-to-year comparison was 75 firms that responded to P&I's survey in both 2015 and 2014.
Global market conditions in the past two years didn't make it easy for a wide swath of managers to generate the alpha expected by institutional investors paying high fees for market outperformance.
“Individual hedge fund strategies started suffering poor returns in 2014. In the summer of 2015, active management really started to struggle and on average, alpha turned negative,” said Kent Clark, managing director and head of the hedge fund strategies practice within Goldman Sachs Asset Management, New York.
“By the end of 2016, after nearly eight years of a global bull market, average hedge fund returns were what you would have expected after adjusting for average beta and performance of most strategies lagged long-only U.S. equities,” he added, stressing that “returns like this generated a lot of unrest among investors.”
GSAM managed $28 billion in hedge funds of funds as of Dec. 31.