Newly Cautious Investors Drive Hedge Fund Growth

Assets reach $4 trillion as institutions look for protection from volatility, inflation, and high stock valuations.

Michael Nagle/Bloomberg

Michael Nagle/Bloomberg

On the back of strong performance last year, the hedge fund industry reached $4 trillion in assets just weeks into January.

According to Hedge Fund Research data, total hedge fund industry capital surpassed $4 trillion in the beginning of the new year, marking a $400 billion increase from the beginning of 2021.

Kenneth Heinz, HFR president, said the growth of hedge fund assets is a reflection of investors repositioning after the shocks of March 2020. Many investors reduced the beta, a measure of volatility compared to the market as a whole, in their portfolios and reevaluated their exposure to stocks.

“For a lot of people, there was a tremendous sense of complacency coming into 2020 because we hadn’t seen a real dislocation or systemic shocks,” Heinz said. “[Now,] it’s a change in mentality towards thinking about the risk inherent in long-only equity and long-only fixed income.”

Some of the world’s biggest hedge funds had a phenomenal 2021. Last year’s top gains were made by Chris Hohn’s $44.4 billion TCI Fund Management, which earned $9.5 billion for investors, boosting its total earnings to $36.5 billion since inception. As previously reported by II, the most profitable strategy on an annual list from LCH Investments was multi strategy, with Citadel, D.E. Shaw, and Millennium making the biggest gains.


The HFRI weighted composite index gained 10.3 percent in 2021, while the investable HFRI 500 fund weighted composite index gained 9.9 percent.

Allocators have been gearing up for the “one-way risk asset valuation party” to come to an end, said Jim Neumann, chief investment officer at Sussex Partners, an alternative investment advisor, commenting on the record high in assets. “A shift to active management, particularly in equities, makes sense from a prudent fiduciary standpoint. Hedge funds are merely one part of that active management shift and are meant to be the most adept at navigating less certain environments via a long-short approach,” Neumann said.

Joshua Leonardi, U.S. head of capital introduction at TD Prime Services, said much of the growth last year was likely fueled simply by performance. He believes the hedge fund industry continues to face the challenge of having to compete with other alternative investments.

“The hedge fund industry is mature,” Leonardi told II. “You’re not going to have..a tremendous amount of institutional investors piling capital into the asset class. It remains highly competitive: Hedge funds are competing against private equity, private credit, natural resources.”

The strongest strategies were event-driven — those focused on out-of-favor, heavily shorted, deep value equity and credit positions — and equity hedge, according to HFR. In 2021, event-driven strategies gained more than $155 billion and surpassed $1 trillion in total. Total capital invested in equity hedge increased by more than $133 billion.

In contrast to HFR, PivotalPath, a hedge fund research and data firm, reported that 2021 was marked by the revival of equity quant. In 2020, the research firm’s equity quant index lost 4.6 percent. In 2021, the index was one of the top-performing.

“In 2021, the drivers of performance are completely different [from 2020],” Jon Caplis, PivotalPath’s CEO, told II. “I view 2020 and 2021 as almost mirror images, other than the overall [positive] performance of hedge funds.”

PivotalPath’s hedge fund composite index returned 7.9 percent in 2021.

The contrast can also be seen in the performance of PivotalPath’s equity sector indices. The healthcare index had a strong 2020, but last year it lost 6.2 percent. The technology, media, and telecommunications, or TMT, sector also posted strong returns in 2020 but generated a loss of 0.8 percent in 2021.

Looking ahead, Caplis said PivotalPath is bullish on hedge funds moving into 2022, particularly with valuations and inflation expectations on the rise.

“Hedge funds actually do quite well in an inflationary environment,” Caplis said. “We expect hedge funds — with their downside protection — to continue to really help with any big portfolio losses.”

Leonardi expects growth to continue, but he cautioned that much depends on investors choosing the best managers from the thousands available. “If you’re an endowment, you may only have 20 hedge funds in your portfolio. Understanding what the manager does and how they fit into the overall portfolio is critical.”