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The Incredible Shrinking Hedge Fund Industry

Assets invested in alternative investment strategies rose by 10 percent globally last year, according to a new survey. The winner? Global credit. The loser: hedge funds.

  • Julie Segal

After years of steady but low growth, the combined assets of the world’s largest 100 alternative asset managers increased by 10 percent in 2016, reaching $4 trillion in assets — no thanks to hedge funds.

The bullish environment for alternatives affected almost every investment category except for these funds, which have endured criticism in recent years for poor performance and high fees. Assets in direct hedge fund strategies dropped more than ten percent, from $755 billion to $675 billion in assets, according to consulting firm Willis Towers Watson’s Global Alternatives Survey 2017, published on Monday. By contrast, assets in illiquid credit strategies more than doubled, from $178 billion to $360 billion.

Investors have talked about their disappointment in hedge funds for years, but this is the first time the survey found a significant drop in assets.

“It took a long time for the numbers to reflect the trends that were already clear in the market,” says Luba Nikulina, global head of manager research for the consultant in London. “Investors are disillusioned with high fees, skewed alignment of interests, and performance problems of hedge funds.”

However, she notes that with capital leaving and volatility rising in the markets, it might be a good time for investors to take another look at the category.

“Compare illiquid credit with hedge funds,” she says. “When people are piling in, it’s time to stop and think. But when capital is flowing out, there’s a possibility of doing something attractive.”

The popularity of illiquid credit grew sharply after the global financial crisis of 2008, as banks stepped away from making riskier loans and asset managers began offering direct lending funds of their own. Nikulina says the ballooning illiquid credit sector may have implications for investors.

“We are quite concerned that the sheer volume of capital flowing to illiquid credit is chasing yield away,” she says. The relatively new asset class, however, may have a permanent spot in portfolios now that institutional investors have gotten comfortable with the strategies.

“As long as banks don’t come back into this space, then institutional capital will likely stay,” Nikulina adds.

The survey found that real estate managers accounted for the largest share of assets of the top 100 alternatives managers, at $1.4 trillion (or 35 percent of the total). Private equity fund managers accounted for 18 percent of the total, with $695 billion, while hedge funds accounted for 17 percent of the total. Global alternative assets under management grew to $6.5 trillion, according to the survey.

The research also shows that pension funds represent one third of total assets invested in the top 100 alternative asset managers, followed by wealth managers at 15 percent, sovereign wealth funds at 5 percent, endowments and foundations at 2 percent, banks at 2 percent, and funds of funds at 2 percent.

Insurance companies are increasing their allocations. Last year, insurers went from 10 percent to 12 percent of the total.

Despite the controversy over the high price tag for investments such as private equity, hedge funds and other alternatives, pension fund assets managed by the top 100 rose 9 percent from the year before. That’s a little more than half their total assets under management. Real estate is their largest allocation, clocking in at 41 percent.

Some notable chart toppers are Bridgewater Associates, which remains the largest alternative investment manager, with $116 billion in direct hedge funds. Blackstone Group is the largest private equity manager with $100 billion and also the largest fund-of-hedge fund manager with $71 billion. Prudential Private Placement Investors is the largest illiquid credit manager with $81 billion in assets, and TH Real Estate, a unit of Nuveen, is the largest real estate manager globally, with $105 billion.