Private equity and hedge funds will find it harder to beat the market going forward than they have in the past, according to a new study by J.P. Morgan Asset Management. The study, a 57-page document published recently, projects that median returns on PE during the next ten to 15 years will match that on a mid-cap long-only stock portfolio, while the median hedge fund will underperform that portfolio. Such a performance would come in sharp contrast to returns over the past 10 years, when PE and hedge funds beat such a portfolio by a minimum of five percentage points, the authors said in an email to Institutional Investor.
The group is looking for roughly 8 percent to 8.25 percent returns for U.S. equities and 8.75 percent for mid-cap stocks annualized over a ten- to 15-year investment horizon, whereas it projects 8.75 percent returns for private equity and 6.25 returns for a diversified portfolio of hedge funds. By specific strategies, it forsees the following annualized returns: 7.25 percent for event driven, 7.75 percent for long bias, 5.35 for relative value, and 7.5 percent for macro.
During the past 10 years, the authors note, such portfolios returned between 5.4 percent and 8.1 percent, while returns for large-cap U.S. stocks have been close to flat, with similar returns for developed market equities overall. During the next decade and a half, however, the study projects that returns for such equities will return to their historical norms of 10 percent.
“We would not suggest investing based on our return assumption for the median manager,” says Anthony Werley, Chief Strategist, Endowments & Foundations Group, J.P. Morgan Asset Management, referring to private equity. He explains that a median private equity manager—without differentiating for size—is not only likely to produce mid-cap type of returns but will often do so with greater risk, as they typically leverage up their portfolio companies.
And investors may have to do even more due diligence than those results alone suggest because the study also finds that the dispersion of manager returns is significantly wider in the alternative strategies arena than in traditional asset classes. This reflects the ability of skilled managers to use leverage and go short, to name just two examples, says Werley. He says the findings indicate that investors in private equity funds and hedge funds must do more homework than they have done in the past to gain much if any advantage from their allocations.
“You’ve got to be much more selective,” Werley says. “The due diligence process becomes much more important.”
