Study: Hedge Funds Suffer Year of Disappointing Returns

(October 11, 2011) — A mere 11% of institutional hedge fund investors have stated that returns on their investments have exceeded expectations in the past 12 months, the latest Preqin study shows.

A total of 40% of investors feel that returns have fallen below expectations in 2011, the report revealed.

“Changes to the hedge fund industry are likely to continue apace as cautious institutional investors seek the best possible fund terms from their fund managers,” Amy Bensted, Manager of Hedge Fund Data, said in a statement. “Fees are of great importance to investors, and it is probable that managers will carry on moving away from the 2&20 structure. Dissatisfaction with hedge fund performance will be of concern to the industry and managers will have to listen to their clients to ensure that they keep them on side.”

Bensted added: “If managers continue to respond to demands from institutional investors, positive inflows will remain in the industry, with the managers best able to adapt to the demands of investors reaping the largest rewards.”

Additionally, the report showed that investors are now less likely to reject a fund based on fee structure than they were last year; 47% surveyed this year said they had done so in the past 12 months compared to 65% in 2010. Meanwhile, one-third of investors said that managers are prepared to charge lower fees in return for longer lock-up periods.

View Preqin’s full hedge fund report here.

While Preqin’s report paints a slightly negative picture for the hedge fund industry, it comes during a time when institutional investors are flocking to the asset class in hopes of higher returns. A recent study by Citi Prime Finance revealed a renewed commitment to the asset class among institutional investors. A June study by the firm showed institutional investors had $1.1 trillion in hedge funds at the end of the first quarter. At the same time, following the global financial crisis, the firm found a noticeable shift to direct investing in hedge funds by pension and sovereign wealth funds, as opposed to using traditional fund-of-funds.

In September, another research report provided further impetus to institutional investors to increase their hedge fund allocations, claiming that US pension funds could up returns by more than $13 billion a year if they reallocate 10% of their portfolios to hedge funds.

“Hedge funds have evolved from an elite investment to a standard component of investment portfolios, and in so doing, offer institutional investors, such as pension funds, the opportunity to improve returns,” wrote the report’s author Dr. Everett Ehrlich, a business economist at Washington-based consultancy ESC Company, who was previously the Under Secretary of Commerce for Economic Affairs in the Clinton administration. “The modeling performed for this analysis suggests that a modest allocation to hedge funds would improve the returns to public pension funds by approximately $13 billion annually. Moreover, the track record of recent years further illustrates that hedge funds have not been a source of greater systemic risk — rather than ‘too big to fail,’ they are generally not an important source of systemic risk,” stated the report, titled “The Changing Role of Hedge Funds in the Global Economy.”