Investors Weed Out Their Hedge Fund Managers

Investors who pulled money from hedge funds last year aren’t bailing on the industry altogether.

The vast majority that redeemed from hedge funds expected to invest their money in other hedge funds, particularly those that they are already familiar with, according to Credit Suisse’s 2019 survey of hedge fund investors. Credit Suisse polled 311 global institutional investors with $1.12 trillion in hedge fund investments. 

Eighty-nine percent of investors who withdrew money from hedge funds in 2018 said they planned to recycle that capital into other hedge funds. The survey showed that allocators are increasingly investing with managers they already hold in their portfolio.

“It makes sense that institutions are reallocating to existing funds as it’s harder than ever to start a new firm,” said Stephen Scott, a partner with BRI Partners, which creates investable indexes for institutional investors. “So with the supply of new strategies and managers down and given that many hedge funds aren’t producing good returns, investors are turning to what they know.”

Hedge fund performance was dismal in 2018. Nearly two-thirds of hedge funds lost money last year, according to eVestment. 

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Forty-one percent of respondents to the survey said they do co-investments with their hedge fund managers, up from 33 percent two years ago and 11 percent in 2013, according to Credit Suisse. Pensions funds and other institutions have become increasingly interested in co-investments, which have lower management and performance fees, as a way to keep costs down and allocate larger amounts to specific investment opportunities.

According to the survey, 51 percent of allocators with hedge fund co-investments aren't paying any management fees on those investments. This included 82 percent of pensions, 67 percent of endowments and foundations, and 43 percent of family offices. Among the investors who did pay management fees on co-investments, most paid fees ranging from 26 to 100 basis points.

Meanwhile, 78 percent of allocators paid performance fees on co-investments, with half paying fees in the range of 6 to 10 percent.

Overall, Credit Suisse said roughly 60 percent of allocations over the past 12 to 18 months went to alternatives, with a focus on customized managed accounts and co-investments. According to the report, the trend of customizing mandates has led investors to cull the list of hedge funds with which they work. The average investor had 31 managers in their portfolios in 2018, down 35% from 2009.

Despite the difficulty of starting a new hedge fund, Credit Suisse reported that more than 70 percent of investors allocated capital to a start-up last year. The top factor investors are taking into account when evaluating new hedge funds, according to Credit Suisse, is the “state of the C-suite.”

“There's a real concern that some hedge fund managers are not going to be around after a couple ” Scott said.