Hedge funds keep lustre despite underperformance

Hedge funds keep lustre despite underperformance

More than four in five institutional investors plan to maintain or increase their investment in hedge funds despite more of them saying alternative investing lost them money last year, according to a new report.

JP Morgan’s annual hedge fund institutional survey found 87% of respondents said they plan to increase or maintain their current allocations to hedge funds in 2017, compared to 81% who invested in these funds last year.

The paper, produced by the investment bank's prime brokerage unit,  also reported 75% of investors said their hedge fund investments did not meet their target return in 2016.

This represents a significant increase from 2015 when two-thirds of respondents reported their hedge fund portfolio did not meet their return expectations.

“Investors have certainly lowered their return expectations from hedge funds over the years,” the report read. 

The percentile of respondents who set a target return below 10% has increased to 66%, from 63% in 2015 and 46% in 2014, the report said.

Some 31% of survey participants believed the main reason for hedge fund underperformance is industry crowding, with too many hedge funds chasing limited opportunities. 

Meanwhile, 21% pointed to macroeconomic factors as the primary factor for underperformance.

“Investors continued to allocate to hedge funds in 2016 despite performance challenges and increased scrutiny,” said Alessandro Tocco, managing director and global head of JP Morgan’s Capital Advisory Group. 

“In aggregate, hedge funds underperformed major market indices and exhibited elevated levels of correlations to equity markets.”

More than 90% of the respondents who increased hedge fund allocations in 2016 did so by investing in new hedge fund managers, while 60% increased allocations to existing hedge funds. 

The survey also exposed how 80% of respondents increased last year their number of strategies, up from about 70% over the past few years. The strategies for the new allocations were led by distressed credit, global macro, quantitative and fundamental long short equity managers.

Fundamental long short equity remains the most popular strategy, with close to 90% of survey participants investing in the model in 2016. This is expected to see the most turnover in 2017, with 20% of respondents intending to increase allocations to the strategy.

Some 90% anticipate lower hedge fund fees in 2017, indicting further fee pressure on managers. 

Two thirds of respondents anticipate the hedge fund industry will continue to consolidate and expect to see more implementation of hurdle rates by fund managers.

Some 234 institutional investors participated in JP Morgan’s 2017 Institutional Investor Survey, representing approximately $750 billion in hedge fund assets under management.

The global hedge fund industry returned an average of 1.16% in January, producing its eleventh month of positive performance in the past year, according to the latest report by eVestment on February 10. 

Over 70% of all hedge funds produced positive results for the second consecutive month.