The large Retreat from Hedge Funds

According to research company HFR Inc. statistics referenced in a thorough Wall Street Journal investigation, equity-oriented hedge funds have underperformed the market over its ten-year bull run, leading to three years of net investor withdrawals—the longest stretch of outflows since 1990. Many of these funds are being forced to close as a result, including those with stellar reputations and top managers in the past.1.

Equity-focused hedge funds beat the S&P 500 Index by almost 5% year on average between 1990 and 2009. They have, on average, underperformed the index since 2010 by almost 9 percentage points annually. According to Greg Dowling of Fund Evaluation Group, an investment advisory company, "investors are frustrated," as reported by the Journal. "Clients expect them to underperform in a raging bull market, but not by a huge degree, for years on end," he said.

Lagging Performance

Hedge funds were lagging behind in 2019. As per the data from BarclayHedge, which was cited in a different Journal article, the S&P 500 gained around 30% in net return, compared to the average of 17.2% for hedge funds. The highest performing funds were referred to be "equity long bias funds," which provide significant unhedged exposure to stocks; yet, their average return was just 20.6%.2.

Jeff Vinik, who took over as manager of the Fidelity Magellan Fund in 1990 from Peter Lynch, died away recently. After that, Vinik started managing hedge funds. He closed the fund in 2013 but reopened it in 2019. In two months, he set out to raise $3 billion, but he only managed to raise $465 million. He decided to give up once again in October 2019.

"What I learned after probably 75 meetings is the hedge fund industry of 2019 is very different than the hedge fund industry when I started in 1996, and it's even very different from the hedge fund industry when I closed in 2013," Vinik said. The fierce competition is one problem. Total assets under management (AUM) increased from $39 billion to $3.2 trillion, while the number of hedge funds increased from 530 in 1990 to 8,200 at present.

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High fees.

There is pressure on fees. These have historically been paid out at 20% of investment gains plus 2% of AUM annually; this is referred to as the "two and twenty" fee structure. An increasing percentage of hedge funds believe they must provide reduced fees. By contrast, the yearly expense ratios of the three largest exchange-traded funds (ETFs) that follow the S&P 500 range from 0.03% to 0.09%.

The growing popularity of quantitative and passive investing is another issue. More quickly than human hedge fund managers, the former takes advantage of pricing anomalies. The latter has led to a more interconnected market for stocks. A research by JPMorgan Chase & Co. indicates that the percentage of stock trading that is done by human stock pickers has dropped from around 45% in the late 1990s to about 15% at this time.

Illiquid Funds

The fact that many hedge funds retain investor money for protracted periods of time is another problem with them. Put another way, an investor is locked in for a number of months or years, even if the fund performs badly. Because hedge funds are not very liquid, it might be difficult to get out of them during recessions.

Hedge fund managers may seamlessly exit holdings and prepare their strategy throughout the lock-up period. Although they may last up to a year, hedge fund lock-ups often last 30 to 90 days and enable the hedge fund management to exit positions without driving prices against their whole portfolio.

The Final Word

According to data from Hedge Fund Research reported by the Journal, global hedge fund assets rose to a record $3.25 trillion, up from $3.1 trillion at the beginning of the year, despite net redemptions of $23 billion in the first half of 2019.2. Despite poor performance, it was enough to offset net capital withdrawals. Still, sustained underperformance will surely scare off even more investors from the market.

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