Hedge Fund Alpha Is on the Wane

Excess hedge fund returns have plummeted since the mid-nineties, and some clients have cut their exposure.

The return generated from hedge fund strategies in excess of their benchmark has deteriorated from an annualized 8.2 percent in the 1990s to just 0.6 percent over the past decade, according to new data.

The discovery, reported in Northern Trust’s 2017 five-year investment outlook, comes a day after a separate UBS report found that family offices had cut their allocations to hedge funds by 1 percent in 2016. The UBS Global Family Office report found that “some movement away from this asset class has been observed for the second consecutive year.”

Earlier this year, a JPMorgan survey concluded that three quarters of large investors were disappointed by the performance of their hedge fund portfolios in 2016.

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Northern Trust’s Capital Market Assumptions report – an annual piece of research providing a five-year outlook that will inform the investment management firm’s asset allocation decisions – was written by some 15 investment professionals including chief investment officers. It predicted that hedge fund strategies will make a 4.4 percent annualized total return over the next five years beginning July 2017.

While hedge funds strategies have the ability to provide uncorrelated returns to traditional portfolio assets, the report stated that the amount of alpha generated by hedge funds has deteriorated considerably since the nineties, citing Bloomberg and HFR as data sources.

Across all asset classes, private equity and emerging market equities were forecasted to perform best over the coming five years, with Northern Trust’s investment strategists predicting an 8.4 percent return for each strategy. However, the report’s authors conceded that estimating private asset returns accurately is difficult due to the absence of public pricing.

As for emerging market equities, predicted to be the top performing traditional asset class, the report suggested that “low valuations and a stable economic outlook allow for some valuation expansion.”

Northern Trust also estimated that natural resources would produce a 7.4 percent total return over the five-year period. While the authors noted that the “modest growth environment” would likely impact demand for the sector, they argued that “demand was not dead” and that underinvestment would “eventually pressure supply.”

Global real estate was forecasted to return 6.1 percent, while global listed infrastructure was predicted to produce a 5.8 percent return over the same five-year period.