Hedge Funds’ Popularity Flags Among Allocators, per Consulting Firm

Hedge funds once were the hot ticket among allocators, but their popularity has waned. Institutional investors are not looking to expand their allocation in the space, according to consultant Agecroft Partners.

These investors, including pension funds, endowments and foundations, “have reached a saturation point in fully allocating a percent of assets to hedge funds,” wrote Don Steinbrugge, Agecroft’s founder and CEO, in its commentary on industry trends for 2024.

If so, that would reverse a trend. Public pension funds devoted 6.5% of their assets to hedge operators as of 2022, the Public Plan Database reported. That’s up from 3.3% in 2010 and 1.8% at the start of the century. Hedge funds in general are expected to grow, from portfolio appreciation, although Steinbrugge indicated he anticipates that to slow to 6% annually from 8% due to tapering allocator investing.

In addition, he found, a number of pension programs are tilting their allocations toward more midsize hedge funds, rather than the largest firms. Indeed, smaller and presumably more nimble hedge managers have generated better results than big funds of late, he said, citing HFRI research: 4.52% versus 3.30% over the 12 months through November 2023.

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Across the spectrum of hedge funds, however, there have been investment outflows over the past couple of years, per Nasdaq eVestment, the stock exchange’s research arm. That amounts to $68 billion taken out in 2023 through September on the heels of $112 billion in 2022. That is 5.1% of the $3.5 trillion in U.S. hedge assets.

Investors have grumbled for a while about hedge fund returns in single digits: 4.8% last year, as of November. Such results pale before the stock market’s 2023 advance, as hedge funds charge relatively high fees for the privilege of investing in them. Hedge funds, for their part, note that they usually are up when equities tank, as happened in 2022.

Perhaps as a result of such allocator qualms, the University of Cincinnati, for instance, intends to cut its hedge fund exposure to 10% of the endowment’s $1.3 billion portfolio, down from 20%. But not everyone is trimming hedge fund exposure. The California Public Employees’ Retirement System, which ditched its $4 billion hedge fund allocation in 2014, is considering getting back in.

This year, long-short equity hedge managers, who offset the risks of stock purchases in underpriced stocks by taking short positions in overpriced shares, should do well, the Agecroft report declared—especially those hedge funds dedicated to value and small- and mid-cap stocks. Reason: The firm expects a reversion to the mean, after a big 2023 runup in tech growth names. Then, the high-fliers would drop and the underdogs would flourish.

For whatever reason, the Hedge Fund Confidence Index slipped in last year’s fourth quarter to 15.6 from 21.6 in the prior period, below the average historical score of 17.7. The Alternative Investment Management Association, which took the survey by polling 235 hedge funds worldwide, asked them to rate their confidence in their funds’ prospects in the coming 12 months, on a scale from negative 50 through positive 50.

For 2024, Agecroft’s Steinbrugge predicted that hedge managers with strong results would gather more investments and the weaker ones would suffer, leading to a consolidation of the field. “Underperforming managers are likely to face above-average redemptions,” he wrote, “leading some to cease operations.”