Hedge Funds Still Losing Investment to Private Equity
Hedge fund performance has bounced back this year after a disastrous end to 2018, but institutional investors are still dropping them from their portfolios in favor of private equity, according to a study by EY.
The "lackluster demand" for hedge funds is tied to performance troubles and high fees — two longtime pain points for investors — as well as competition from other products in the alternatives space.
The EY study found a disconnect between hedge fund managers' priorities and those of their investors. For example, growing assets was the top priority for most hedge fund managers who were surveyed, while investors' top priority was cost rationalization.
A study from EY released Wednesday surveyed 62 institutional investors with $1.8 trillion in combined assets and found they were replacing their hedge funds — and didn't plan on stopping soon.
After making up 40% of these investors' alternatives allocation in 2018, hedge funds now make up only 33%. At the same time, private equity has grown its share of the pie to 25% this year from 18%.
"Investors do not expect this trend to change over the next two to three years, having reported that they anticipate their allocation to private equity and real estate products to continue to grow," the report said.
EY noted that performance troubles and high fees had led to less investor interest in hedge funds. Additional factors are competition from other alternative investment options like real estate and private credit. So far this year, the $3.2 trillion hedge fund industry has seen a net loss of $77 billion, according to eVestment.
But a disconnect from investors, as shown by EY's report, may also be costing hedge funds assets. The top priority for a majority of the 102 hedge fund managers surveyed was asset growth and fundraising, while investors said cost rationalization was the top priority they wanted their managers to have.
And four out of every 10 investors said succession planning should be a top-three priority, while only 13% of hedge fund managers said the same.
Investors are "increasingly desiring long-term partnerships with their managers," said Ryan Munson, a partner in EY's wealth and asset management division who was one of the report's authors. Hedge funds' slump has many managers focused on just getting through the short term and "not thinking five to 10 years down the road" the way many pensions are.
More than a decade removed from the financial crisis, investors are looking for "complex, illiquid strategies" that private-equity firms provide, Munson said, as liquidity has become less of a concern.
At the Greenwich Economic Forum last week, Paul Colonna, who runs Lockheed Martin's $80 billion pension plan, told attendees that while 60% of his portfolio could be traded in a single day, he's not thinking about liquidity when making an investment.
"Of all the things I'm worried and concerned about, liquidity is not one of them," he said.
The EY report also found that private equity's internal policies were more in line with investors' values. Nearly two-thirds of investors who invest in sustainable products said a manager's internal environmental, social and governance policy on everything from hiring to investment decisions was "critically important."
On the manager side, firm-wide diversity is lacking at hedge funds more so than in private equity, EY found. Roughly half of private-equity managers had set diversity targets, while only 15% of hedge funds had. Women made up less than 10% of hedge funds' front offices — where investment decisions are made — from a majority of the survey's participants.
Still, neither private equity nor hedge funds have what would be a considered a diverse industry. Only one in every 10 firms, including both hedge funds and private equity, reported that women made up more than 30% of their front office.
"There is quite a ways to go for the entire industry," Munson said.
By Bradley Saacks for Business Insider: https://www.businessinsider.com/investors-are-dropping-hedge-funds-from-portfolios-for-private-equity-2019-11?IR=T