Investors Redeemed Nearly $100 Billion from Hedge Funds in 2019

Investors redeemed nearly $100 billion from hedge funds in 2019, marking the second consecutive year of outflows in the industry as managers struggle to retain investors in search of alpha elsewhere, a recent study says.

Despite delivering a better-than-usual performance year, hedge funds tallied $97.9 billion in outflows in 2019, up 163% from nearly $37.2 billion the prior year, according to an eVestment report released last week. The industry last posted two successive years of redemptions in 2008 and 2009, during the Great Recession.

“The industry will likely live on as a place where the best survive and the belief in emerging stars persists,” the report read. “But 2019 also seems to have marked the point where one can no longer ignore that broadly felt success is a thing of the past.”

Deterred by high fees and hoping to reduce exposure to public equity markets, investors have been pulling money from hedge funds in favor of private equity, credit, and real assets. In an exodus, lenders are instead allocating money from hedge funds and other long-only equity strategies to external asset managers around the world, the study said.

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Hedge funds have dismally lagged broader indexes. In the last 12 months, the industry posted just 7.4% in returns. That was less than one-third the showing of the S&P 500, which gained 27% over the same time period, according to Bloomberg. Meanwhile, more than 4,000 hedge funds have closed in the past five years, according to Hedge Fund Research.

Still, thanks to performance gains, there were some bright spots in the industry. While the industry posted its largest annual outflow since 2016, hedge funds last year increased assets under management by 4% to $3.3 trillion, largely due to new assets received in macro funds. In 2020, pension funds, seeking low interest rates, are also expected to increase allocations into hedge funds.

Hedge funds are not the only ones feeling the squeeze. Long-only U.S. equity strategies, which have about $7.1 trillion in assets under management, suffered redemptions of 5%. By comparison, hedge funds underwent withdrawals of about 3% of AUM.

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Global pension fund assets are expected to grow at a 5.4% compound annual growth rate between 2018 and 2025 to $61.1 trillion from $42.2 trillion, according to a report from the Association of the Luxembourg Fund Industry, a non-profit trade association.

The report said that because of rising life expectancies in many countries, pension funds are “facing a crisis of unprecedented proportions,” and as a result must increase their yield in order to meet the growing number of individuals reliant on them.

“To generate higher returns and meet their mandates, pension funds are increasingly diversifying their portfolio both in terms of asset class and geography,” said the report.

According to the report, equities accounted for the largest asset allocation for pension funds worldwide at 38% of total pension assets as of the end of 2018. This is a sharp drop, however, from 60% in 1998 as pension funds have diversified their portfolios in search of assets that increase their alpha, such as alternative investments.

Bonds remained a core of pension fund portfolios despite low interest rates, and accounted for 29% of global pension fund assets, up from 28% in 2014. Alternatives, which are expected to play an increasingly important role in pension funds’ portfolios, made up 27% of pension fund assets in 2018, up from 26% in 2014. In absolute terms, alternatives assets have grown during that time to $11.6 trillion from $9.2 trillion.

“In light of the current global investment environment, pension funds, with their ability to weather periods of market instability, are also upping their allocations to alternatives, including notably illiquid assets such as private equity and infrastructure,” Oliver Weber, head of asset and wealth management, PwC Luxembourg, said in a statement.

Weber said that in addition to diversifying by asset class, pension funds are seeking higher returns by diversifying by geography and going “beyond their borders in search for growth.”

North America remains the main domicile for pension assets, accounting for 61% of the global market at the end of 2018; however, Latin American funds saw the strongest growth with assets rising at an 18% CAGR.

“Many pension funds are increasing their foreign investments to tap into thriving foreign markets to increase returns and reduce volatility,” said the report. “Increasing foreign exposure also helps to mitigate local company and sector risks.

The report said that in countries with a highly volatile currency, investing abroad can help reduce exposure to exchange-rate risks by hedging against currency rate changes. High local inflation could also be a source of motivation for investing abroad.

The report also said pension funds were increasingly investing in sustainable assets, which saw a 34% increase in two years as of the end of 2018.

“A new environmentally conscious generation of investors while looking for strong returns, are also looking for their investments to have an impact,” said the report.

The report also found that as many pension funds search for value for money, they are turning toward low-cost index trackers, and away from high-fee active funds. This is because many active funds have underperformed in the last few years. However, it said active will still remain the largest part of the industry.

“In fact, as passives continue growing, pension funds will need active managers to deal with some of the inefficiencies that may result from a passive driven market,” said the report. “Passive rise is a foundational change in the way pension plans now manage their portfolios as both active and passive are needed.”

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