Hedge funds see investment exodus amid faltering performance

If money talks, then one of the things it has been saying this summer is that investors are no longer interested in hedge funds. Investors withdrew $25.2bn from hedge funds in July, according to eVestments. This is the largest monthly redemption since February 2009, when investors redeemed $28.2bn.

This news comes after investors withdrew $23.5bn in June. Overall, in 2016, hedge funds faced a net outflow of $55.9bn. According to Peter Laurelli, vice-president and global head of research at eVestments, 2016 could become the third year on record when investors took out more money than they put in.

The main reasons why investors are taking their money elsewhere? Poor performance.

“Investor redemptions from the industry continue to be driven by mediocre performance. Funds producing losses in 2015 are by far the primary source of outflows throughout the year into July,” Laurelli wrote in his report. “Additionally, in both June and July, redemptions have accelerated from within funds producing losses in 2016. Funds reporting the 10 largest outflows in July have returned an average of -4.1% year to date, with average losses of -5.3% concentrated in the first quarter.”

Laurelli pointed out that some hedge funds were doing well – especially those who produced higher returns for their investors.

“The 10 largest allocations in the last two months have gone to funds which have produced an average return of nearly 7% this year, and produced positive returns on average in 2015,” he wrote. “That we are forced to illuminate positive sentiment in the proverbial ashes, only illustrates the difficulty faced by many.”

In 2016 hedge funds have delivered returns of 1.2% industrywide, while S&P 500 delivered returns of about 7.6%, according to Bloomberg.

The trouble for hedge funds started in 2015, when over the last three months, investors globally withdrew more money than they put in, according to Hedge Fund Research. The research firm also reported that 979 hedge funds closed last year – most since 2009.

The industry is expected to shrink further this year. According to Blackstone Group president Tony James, the industry might lose as much as 25% of assets this year.

“It’s kind of a day of reckoning that we face here,” James said during a May interview with Bloomberg TV Canada. “There will be a shrinkage in the industry and it will be painful. That’s going to be pretty painful for an awful lot of places.”

BlackStone is the world’s largest discretionary hedge fund investor. In the second quarter of 2016, the firm allocated $68.6bn to hedge funds.

Despite the faltering performance and the varying investors, hedge fund compensation remains high. According to James, the hedge fund fees are “hard to justify these days”.

Hedge-fund managers typically charge a 2% management fee on the assets they manage as well as an incentive fee, which is usually 20% of the profits. Last year, the world’s top 25 hedge-fund managers earned $13bn. That’s more than the entire economies of Namibia, the Bahamas or Nicaragua.

James is not the only one to voice displeasure over hedge-fund fees. Warren Buffett, world’s third richest person, described the fees as an unbelievable compensation scheme. And Bill Gross, portfolio manager at Janus Capital, described the 2-and-20 fees as “a giant ripoff”.

“If markets only provide 3% or 4%, they are taking more than half of the money that the investor gives them in terms of the annual profits,” Gross told Bloomberg. “Things have to change and people have to wake up [and realize] that it’s a different world now.”

His comments came just days after that Tudor Investment, one of the oldest and most expensive hedge funds, informed its clients that it was cutting fees for one share class from 2.75% of assets and 27% of profits to 2.25% and 25%.