It was a really bad quarter for the hedge funds industry which continued to shrink in the second quarter of Q2 2016, despite continued growth in investors’ capital to a record level. Uneven performance failed to reassure clients frustrated by high fees. The pain suffered by hedge funds was seen as investors exhibited low tolerance for underperformance, resulting in an elevated number of liquidations, according to a Bloomberg report.
More hedge funds were shut in the first three months of 2016 and outstripped the number of new funds that were launched during the same period. According to data published on Thursday by Hedge Fund Research Inc., 291 firms were liquidated and only 206 started. This is the second consecutive quarter that the number of closings of hedge funds exceeded new launches.
There was one sign of improvement, though. The figures represent a slowdown in closures from the Q4 2015, when 305 funds closed, but an acceleration from the 217 seen in the first quarter of 2015. In the past 12 months, 910 funds launched while 1,053 funds got liquidated, up from 864 closures seen in 2014. Last year saw the most closures since 2009, when 1,023 funds closed in the wake of the credit crisis that took place in 2008.
From a historical perspective, the number of hedge funds has swollen in the past two decades, with current estimates putting them in excess of 10,000, more than twice the number of active firms in 1990. At that time, the industry was managing less than $40 billion, while the number now is close to $3.0 trillion. At first glance, the huge growth may assume a similar increase in the returns that the industry had delivered. But in fact, the aggregate performance of the industry has deteriorated over time.
The latest findings are also in contrast with the Credit Suisse’s study, entitled “Staying the Course”, in which responses on key industry trends and forecasts from 369 institutional investors, representing $1.1 trillion of hedge fund investments, were analyzed.
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The survey was published in March and saw an overall positive sentiment for the hedge fund industry with investors forecasting a 3.5 per cent increase during 2016. Among the surveyed respondents, 87 per cent of investors indicated that they would maintain or increase their hedge fund allocations in the coming year, and were optimistic for further growth in the industry. Only 2 per cent of investors highlighted a lower target weight of hedge funds in their portfolio as the key driver of their redemptions last year.
The Fees Are Worth It
The big question now is not only about the negative shift in investors sentiment during the first quarter, but also what are the reasons behind an incredibly underwhelming picture for the hedge fund industry in the last two years, indicating structural defects. One point could be that the consistent underperformance by many hedge funds and the high fee structure have finally come under intense scrutiny.
The investors’ concerns about high fees were reflected by the new-established funds which had slightly lower management fees in Q1, down 0.12 percentage points to 1.48 per cent, while incentive fees ticked up 0.75 percentage points to 18.5 per cent.
“The environment for new hedge funds continues to be extremely competitive with discriminating investors exhibiting low tolerance for underperformance,” said in a statement Hedge Fund Research’s president Kenneth Heinz.
“Allocators struggling to meet return targets are focusing on “near-term performance, demands for greater liquidity to accommodate more frequent rebalancing activities, and heightened sensitivity to fee structures,” he added.
That said, the hedge funds are often paid through a compensation structure commonly known as the “2 and 20”, where they charge investors 2% of total assets under management and 20% of any profits. These fees can vary though, with some funds charging less and others charging more.