Are We on the Verge of a Hedge Fund Renaissance?

hedge-fund-renaissanceHedge funds have generally lagged long-only exposure to the U.S. stock market the past several years, and this has led to unhappy hedge-fund investors and increasing redemption pressure on hedge-fund managers. But according to Willis Towers Watson, which recently published its Global Alternatives Survey 2016, this might actually be “healthy” for the industry. And if the firm is right, we could indeed by on the cusp of a hedge-fund renaissance.

State of the Industry

According to the Willis Towers Watson report, total assets of the top 100 alternative investment managers grew by 3% to $3.6 trillion in 2015. Hedge funds accounted for 21% of the total, second only to real estate, which accounted for just over one-third of the full sum. Nevertheless, hedge funds’ share of all alternative assets actually grew by 1% in 2015, while real estate’s declined by the same amount.

Alternative Assets Comparison 2014-2015

So why does Willis Towers Watson think redemption pressures related to underperforming the U.S. stock market could be “healthy” for hedge funds? Perhaps it’s because hedge funds are primarily tools for enhancing diversification and lowering correlation, rather than for generating outsized returns during long-term equity bull markets. It could be considered “healthy” to weed out investors who are looking for aggressive returns, since they could potentially steer hedge-fund managers into “unhedged” strategies that would undermine other investors’ objectives.

As Willis Towers Watson points out, hedge funds are not an asset class. If investors are looking for “diversifying return drivers” they can find them outside of the hedge fund space, usually with much lower fees, such as “smart beta” ETFs. There is some risk, however, of “crowding,” since these strategies have become so popular recently.

Future Outlook

While there are certainly regulatory, global macroeconomic, and technological headwinds facing the hedge-fund industry, the need for investors to diversify their portfolio holdings has arguably never been stronger. This should encourage investors to seek out hedge funds for the right reasons – to diversify and lower correlation – rather than in pursuit of big gains (like the hedge-fund traders in unrealistic Hollywood movies and cable TV dramas).

Willis Towers Watson anticipates continued growth in the “alternative beta” space, which could put more pressure on hedge funds, and even liquid alternative funds employing hedge-fund strategies. But this challenge also presents an opportunity for hedge-fund managers to focus more on what they’ve traditionally done best. As the need to diversify away from the record-low yields of the investment-grade fixed-income market and the meager anticipated returns of developed-market equities, we could be on the verge of a hedge-fund (and hedge-fund strategy) renaissance.

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Jason Seagraves contributed to this article.