Hedge Funds Defy Naysayers

Terry Flanagan

Despite lackluster performance over the past half-decade and a highly publicized loss of a huge client less than a year ago, hedge funds continue to attract assets.

Investors turned over $12.1 billion to hedge fund managers in June and $48.6 billion in the second quarter, according to eVestment. The quarterly inflow was the second-largest in six years, and the number is about equal to the assets under management of Och-Ziff Capital Management, which ranks as the world’s third-largest hedge-fund firm.

Hedge funds gained about 4% on average in the first half of 2015, compared with a flat return for the benchmark S&P 500 Index. But the outperformance was the exception to the rule of the past five years, in which the S&P’s annualized return of about 15% beat hedge funds by more than six percentage points.

On top of the unimpressive and widely cited return comparisons, the hedge-fund sector suffered a black eye in September 2014, when California Public Employees’ Retirement System said it was dumping hedge funds because of their complexity and cost. The $4 billion withdrawal was a drop in the industry’s $3.1 trillion asset bucket, but CalPERS is a pension standard-bearer and some observers expected it would trigger copycat pullouts.

Don Steinbrugge, Agecroft Partners

Don Steinbrugge, Agecroft Partners

Not only did that not happen to any discernible degree, but many pension funds “did the opposite and increased their allocations to hedge funds,” according to Don Steinbrugge, managing partner at hedge-fund marketer Agecroft Partners.

Feedback has “consistently been very favorable towards hedge funds across investor types,” Steinbrugge wrote in a release this week. Agecroft expects hedge funds to take in $100 billion in assets over the next year, and add another $180 from investment returns, based on a projected average return of 6%.

“This prediction raises the questions: Where is the disconnect between the stories in the mainstream  media, and the attitude and behavior of many of the most highly sophisticated institutional investors who are responsible for a majority of the assets flowing into the hedge fund industry?,” Steinbrugge wrote.

In response to his own question, Steinbrugge noted hedge funds cover a wide variety of investment strategies and as such institutional investors generally do not use the S&P 500 as the benchmark. Additionally, hedge funds add value to an institutional investment portfolio beyond the absolute return they can generate.

A hedge-fund portfolio has “a low correlation to long-only benchmarks, which can improve portfolio diversification and potentially provide downside protection during a market selloff,” Steinbrugge wrote.

Hedge funds are also benefiting from historically low bond yields, which have institutional asset owners expecting only 2.5% to 3% annual returns from fixed income, compared with 4% to 7% for hedge funds. “As long as the expected return is higher for hedge funds than fixed income, we will continue to see money shift from fixed income to hedge funds,” Steinbrugge wrote.

Featured image via Gee/Dollar Photo Club

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