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Investors Plan To Boost Their Hedge Fund Allocations, But Not Because They Expect Strong Returns


After two years of investor outflows, hedge funds finally turned the corner in 2021, recording a commanding $25 billion in net investor inflows. The industry hasn’t yet recouped the outflows it recorded over the previous two years, but it does look like things are looking up for hedge funds based on investor intentions for the first half of 2022.

Investor interest in hedge funds is recovering

In partnership with the Alternative Investment Management Association (AIMA), With Intelligence surveyed more than 200 allocators in the U.S. to try to determine what lies ahead for hedge funds in the coming year. It found that investor interest in hedge funds has recovered to where it stood in December 2020.

Investors became less interested in hedge funds in 2021, especially toward the middle of the year due to excessive equity prices and what With Intelligence describes as “questionable alpha generation” in the first half of the year. The global hedge fund industry returned about 10% in 2021, broken down by 9% in the first half of the year and 1% in the back half.

With Intelligence believes that growth could be seen more as looking ahead to 2022 instead of being a ringing endorsement of recent returns. However, hedge funds are better positioned now than they have been in years, as they just completed their third straight year of double-digit returns, leaving investors with a more favorable view of them.

Additionally, interest in most alternative asset classes, including hedge funds, continues to rise due to another 12 months of high asset valuations, low interest rates and cheap money. While there’s been an increase in investors interested in hedge funds, the percentages of those looking at private equity and real assets have also been steadily increasing. On the other hand, there has been only a minimal change in interest on an already-high base of those looking for real estate and private credit.

Increasing allocations to alternative assets

About half of U.S. allocators are planning to boost their investments in hedge funds in the next 12 months, including 62% of family officers, 55% of foundations and endowments, and half of corporate pensions. However, only 26% of public pensions planned to increase their hedge fund allocations.

That marks a significant change from June 2021, when only 32% of allocators planned to boost their hedge fund investments. However, it’s roughly flat from December 2020, when 52% of investors planned to invest more in hedge funds.

On the other hand, interest in private equity, the only other asset class in which there is more interest than in hedge funds, has been rising steadily. In December 2020, less than 30% of U.S. allocators planned to increase their PE investments. That percentage rose to 39% in June 2021 and 57% in December.

Why allocators plan to boost their hedge fund allocations

The number one reason for increasing hedge fund allocations in the next 12 months for three of the four investor types was reaching their target allocation, with about 40% of the allocators in each category giving it as their top reason. However, equity valuation concerns were tied for first place with reaching their target allocation for corporate pensions. Additionally, 46% of family offices, which have the highest percentage of allocators planning to boost their hedge fund allocations, gave concerns about equity valuations as their number one reason.

35% of foundations and endowments and 20% of public pensions gave equity valuations as their top reason for boosting their hedge fund allocations. Thirty-one percent of family officers and 20% of public pensions were worried about low fixed-income yields.

Forty percent of public pensions cited exciting new opportunities as a top reason for boosting their hedge fund allocations, putting this reason tied with reaching their target allocation. Thirty-three percent of foundations and endowments, 20% of corporate pensions, and 23% of family offices cited exciting new opportunities.

The surprisingly less important reason

Perhaps the most interesting finding from the list of reasons for boosting hedge fund allocations is investors’ expectations of strong returns. In fact, strong returns were not in the top three reasons of any of the four investor types, and they did not even crack the top five reasons for public pensions or family offices, which had the highest percentage of allocators planning to increase.

Only 13% of foundations and endowments and 20% of corporate pensions cited expectations of strong returns as one of their top reasons for increasing their hedge fund allocations. That revelation says a lot about what investors expect from fund managers from a performance standpoint, which is not much.

However, it also demonstrates that investors seek hedge funds for their diversification benefits or to protect their wealth rather than outperform the market. In fact, the low ranking that allocators gave to strong returns suggests that they understand other findings that have indicated that hedge funds, in general, tend to provide more beta than alpha.

FactorResearch founder and CEO Nicolas Rabener says in a recent post for the CAIA Association that the Credit Suisse Equity Market Neutral Index, which evaluates the alpha generation of hedge funds, has returned 0% over the 17 years between its inception in 2004 and 2021. He noted that the markets have become “highly efficient with few arbitrage opportunities left for exploitation,” making running a hedge fund more and more challenging.

As a result, most hedge funds are providing beta because alpha is so hard to come by due to soaring stock valuations. Rabener also states that investors are benefitting from improved analytics and data, which have enabled them to realize that the majority of hedge fund strategies are “mere beta plays.”

Long/ short equity is the hottest hedge fund strategy

Interestingly, the most sought-after hedge fund strategy right now is long/ short equity, with 31% of investors looking for fund managers following that strategy. Family offices, in particular, are seeking long/ short equity managers, with 48% of them identifying that as the strategy they plan to boost their exposure to. Thirty-five percent of foundations and endowments and 21% of public pensions are seeking long/ short equity funds. However, no corporate pensions had any interest in long/ short equity.

With Intelligence noted that equity valuations are a prime concern for foundations and endowments and family offices, which must be why they are seeking long/ short equity funds. The firm added that institutional investors remain concerned about lingering geopolitical tensions and the pandemic, both of which are driving their increased appetite for long/ short equity fund managers.

Two issues have distorted valuations, creating challenges in traditional asset investing. Smaller investors like family offices see high valuations and market uncertainty as primary factors that are made worse by the challenges that they face accessing some of the larger private market and real asset opportunities that would be able to help them deal with the low yields they face in fixed income.

Next up: multi-strategy

The second-most sought-after hedge fund type was multi-strategy, with 30% of all investors seeking multi-strategy funds. The survey found that 33% of family offices, 30% of foundations and endowments, 16% of public pensions, and 40% of corporate pensions want to boost their exposure to multi-strategy hedge funds.

Multi-strategy hedge funds are seen as best placed to help investors navigate out of the pandemic and rising interest rates. The firm added that the popularity of multi-strategy funds speaks to the one-third of foundations and endowments who cited new investment opportunities as their top reason for increasing their allocations to hedge funds.

Interestingly, macro hedge funds didn’t even crack the top five strategies, settling toward the bottom of the list despite interest from corporate pensions.

Recent strategy performance

19% of all investors, family offices, and foundations and endowments want to increase their allocations to event-driven funds. Eleven percent of public pensions and 10% of corporate pensions also expressed an interest in boosting their event-driven exposure.

However, With Intelligence believes the outperformance among event-driven hedge funds may be over after a robust 2021 return of 14.9%, which made it the best-performing strategy of the year. The firm thinks that could be due in part to softening investor expectations for post-COVID mergers and acquisitions or that “a natural ceiling for the strategy’s value in portfolios has been reached.”

With Intelligence also found it somewhat surprising that interest in CTA funds was so low, as the strategy wasn’t even in the top five. The firm pointed to “some relatively large inflows” and a solid average return of 8.3% in 2021 following years of “underwhelming performance.”

Hedge fund interest by geography

<ost U.S. allocators appear to be uninterested in hedge funds with a focus outside the U.S. The firm said hedge funds in the Asia-Pacific region are slightly more preferred than Europe, especially among foundations and endowments.

The proportion of foundations and endowments that prefer the Asia-Pacific region to Europe is nearly double. With Intelligence also said its data suggests that European managers with a European focus face an uphill battle attempting to convince U.S. allocators to invest with them.

Hedge fund flows

Looking at hedge fund flows for 2021 reveals an excessively bumpy ride. Overall, investors poured a net $25 billion into hedge funds last year with positive months in January, February, April, May, July, August and October. The pattern of positive and negative months was “largely mapped to the usual quarterly redemptions cycle.”

However, the outflows recorded in December were significant at $30.9 billion, revealing a significant shift in investor views of hedge funds as the year came to a close. For comparison, December 2020 brought outflows of only $5 billion. Hedge funds recorded $15 billion in total outflows in 2020 and $17 billion in outflows in 2019.

The firm believes that the elevated outflows in December 2021 are partially due to concerns about the world’s central banks losing control of inflation, the possibility of stock prices being struck down by policy tightening, and the emergence of the omicron variant of COVID. However, 2021 was particularly noteworthy because it was the first year of net inflows for hedge funds since 2017.

Looking into 2022

The firm believes that if this year follows the same patterns as last year, there will be both winners and losers in terms of flows among hedge funds. With Intelligence said its data suggests that hedge fund allocations will flow from foundations and endowments and family offices to global and North American long/ short equity and multi-strategy funds.

In a broader sense, the firm believes anecdotal evidence suggests other strategies and especially the Asia-Pacific region are also well-placed, amounting to “plenty of reasons to be optimistic.”

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