Hedge fund assets have hit record highs in each of the five past quarters, to some $3.2 trillion, and will grow by 5.5% over the next 12 months, according to Don Steinbrugge, head of Agecroft Partners, in his annual predictions of industry trends.
Assets have risen despite a drumbeat of bad news about hedge funds, Steinbrugge said. "There is clearly a disconnect between the mainstream media's coverage of the industry and the reasons why investors continue to allocate to hedge funds. Across the hedge fund investor landscape, we see a significant improvement in sentiment towards the industry."
Three brand-name hedge fund managers were recently sued by the Kentucky Retirement System for failure to deliver on their promises.
Steinbrugge said certain strategies and individual managers have performed well in recent years. Those that have not will see above-average withdrawals, with some of their assets reinvested with better performers in the same strategy. Most of those assets will flows into other strategies in which investors expect active managers to add value.
He said traditional long/short equity managers focused on developed markets and high-beta fixed income managers will likely lose assets.
These will gain assets, he said:
- Quant, which comprises multiple categories, is currently the strategy of seven of the 11 largest hedge fund firms
- Asia long/short equity: The IMF predicts that two-thirds of world growth will come from Asia over the next five years
- Reinsurance: The expectation of price hikes in 2018 has recently led to significant demand
- Higher turnover fixed income strategies that provide liquidity to complex/less liquid fixed income securities
- Strategies that blur the lines between private equity and hedge funds
Following are Steinbrugge's predictions for the biggest trends in the hedge fund industry in 2018:
1. Arms Race for Alpha
The industry is experiencing an information arms race with respect to how much information can be gathered and how quickly it can be processed. Many managers are trying to bolster their decision making and improve traditional investment process by investing in new technologies, such as quantitative analytics, alternative data sources and artificial intelligence.
"Data scientist" has become a key position at many big firms, Steinbrugge said, responsible for amalgamating and leveraging information from web traffic, social media sentiment, online chat rooms, and GPS and satellite imagery to generate actionable forecasts on industries and companies.
2. Increase in Hedge Fund Closures
Steinbrugge said the industry remains oversaturated with some 15,000 funds, about 90% of which do not justify their fees, as evidenced by the mediocre returns of hedge fund indexes. Redemptions from underperforming managers will result in an increase in fund closures.
Both large established managers and emerging ones will feel the effects, he predicted. Some prominent managers' strategies may no longer offer the alpha-generating opportunities that historically drove performance, while other large managers are simply too big to maintain an edge. Those with less than $100 million in assets — the majority of hedge funds — are being squeezed from both the expense and revenue sides of their businesses.
Size or fund tenure notwithstanding, poor performance will accelerate the outflows of capital and in some cases result in fund closures. Unfortunately, however, strong performance in a sustainable strategy will not suffice to generate inflows of capital. Hedge fund flows are increasingly driven by brand and distribution, which smaller hedge funds lack.
"We estimate only 2% of assets are flowing to these managers. As a result we expect the closure rate to continue to rise for small and mid-sized hedge funds."
3. Pension Funds Evolving How They Use Hedge Funds
