Hedge Funds May Be Falling Out of Favor — Again

Investors are concerned that frothy asset valuations, stock market volatility, and rate hikes will weigh heavily on returns this year.

Nathan Laine/Bloomberg

Nathan Laine/Bloomberg

Allocators’ interest in hedge funds may be waning. At least that’s what they told Preqin before Russia invaded Ukraine, a bloody war that has upended the country and global markets.

According to research and data firm Preqin, only about 10 percent of allocators said they were “more aggressively” investing in hedge funds and accumulating assets as a result of their outlook for equity markets. In November 2020, double the proportion of investors, about 20 percent, were doing the same, up from less than 10 percent the year before.

Returns may be partly to blame. The performance of the average hedge fund has declined from its peak of 18.9 percent in 2020, to 13.7 percent in 2021, according to Preqin’s latest investor outlook report. Only 49 percent of investors classified the performance of their hedge funds as acceptable last year; 28 percent said returns fell short of their expectations, according to the research firm. PivotalPath’s hedge fund composite index returned 7.9 percent in 2021.

The report is based on a Preqin survey completed in November 2021 of more than 350 allocators on their expectations for a variety of alternative assets, including private equity, private debt, real estate, hedge funds, infrastructure, and natural resources.

Getting a good read on allocators’ intentions for hedge funds isn’t always easy. Based on a survey done in December, the Alternative Investment Management Association expected about half of U.S. allocators to increase their investments in hedge funds in 2022, in part because of the spike in volatility. Hedge funds can often provide portfolio protection in stressed markets.

Investors are far more optimistic about their private market strategies than hedge funds. According to the recent Preqin study, 90 percent of investors in a broad range of private capital strategies said returns met or exceeded their expectations in 2021, compared to 72 percent in hedge funds.


Part of the reason why investors have become a little jaded about their hedge fund investments comes down to the overall market cycle. Forty-three percent of survey respondents believed the market is approaching its peak, and 22 percent said the market has already passed the high, according to Preqin. Private strategies, whose underlying investments are priced quarterly, don’t always reflect current market values.

Promising opportunities also diminish when valuations are rich. “Markets have generally calmed and the dislocations are slowly disappearing, making it hard for managers to find high-return opportunities,” the report said. “Investors are fully aware of this.”

The United States remains the top investment destination for hedge fund investors. In emerging markets, China, Southeast Asia, and India present the best opportunities, according to Preqin.

Hedge fund investors are concerned that frothy asset valuations, stock market volatility, and rate hikes will weigh on hedge fund returns in 2022, according to Preqin.

In terms of timing, 55 percent of LPs said they plan to invest in a hedge fund in the first quarter of 2022, while 17 percent said they would not commit until 2023 or later. “Based on the results of our survey, it seems investors are more circumspect this year and are cautious with their allocations, as the industry deals with changes in the market,” the report said.