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Hedge funds face a year of net outflows

Commuters heading into the City of London walk in the rain across London Bridge, in front of the Shard skyscraper, in central London on June 27, 2016.
Odd Andersen | AFP | Getty Images
Commuters heading into the City of London walk in the rain across London Bridge, in front of the Shard skyscraper, in central London on June 27, 2016.

The recent run of solid performances by hedge funds has not been enough to stem outflows or endear fund managers to frustrated investors, industry experts have told CNBC, warning that 2016 could be the first year since the global financial crisis that the industry suffers net outflows.

According to Hedge Fund Research, its HFRI Fund-Weighted Composite Index returned 0.4 percent during August, bringing year to date returns to 3.49 percent. This far shy of the equity benchmark return of 7.80 percent and the bond benchmark return of 7.19 percent over the period.

Hedge funds still haven't made up for a torrid first quarter when most strategies suffered punitive losses during January and February - a period characterised by the highest volatility seen since summer 2015. When markets began to calm in March, many funds were unable to keep up with soaring prices across asset classes from equities to bonds and oil.

With interest rates pegged at record lows or even in negative territory across many key markets, fund managers have highlighted the difficulty of outperforming in a climate where a dearth of available investment options has led to overcrowding in popular trades.

According to Neil Dwane, Global Strategist at Allianz Global Investors told CNBC in an email: "Quantitative easing has forced investors to crowd into the least 'most expensive' areas to earn a return or yield, while negative rates have also affected investors' ability to leverage effectively".

But investors' patience is wearing thin. A recent survey from data provider Preqin alleged 79 percent of institutional investors believed hedge funds had failed their performance expectations over the past twelve months with nearly two fifths planning to reduce their exposure to the asset class in the coming year.

This is reflected by trends highlighted in UBS's recent Global Family Office report which reported wealthy families were steadily reallocating from hedge funds towards alternative assets – such as private equity, private debt and infrastructure – in a pattern set to continue.

Indeed, according to Preqin CEO, Mark O'Hare told CNBC in an email: "The term 'alternative assets' is increasingly becoming something of a misnomer. Far from being an 'alternative', it is clear that investors have come to rely on these asset classes as integral parts of their portfolios given good returns in recent years and low correlation between these investments and more traditional equities and bond markets."

Hedge Fund Review data also indicates hedge funds have now seen three consecutive quarters of outflows and a net number of fund closures so far this year. Should this trend continue, this will be the first year since 2008 that hedge fund liquidations outpace launches.

This stands in stark contrast to hedge fund of funds which have experienced net closures every year since 2009. Hedge fund of funds invest in a portfolio of other hedge funds rather than directly into assets.

The difference is likely somewhat attributable to the additional layer of fees investors pay to put money into hedge fund of funds. UBS claims family offices are becoming increasingly attentive to fees charged and are looking to rationalise where possible. In such a low return environment, every basis point that can be retained by the investor and not paid out in fees counts more than ever.

Preqin's research cites fees and performance as the two biggest sources of investor unhappiness regarding hedge funds. This comes as calls mount for hedge funds to rethink their fee schedules.

At the Delivering Alpha conference, co-hosted by CNBC in New York City this week, Stelliam Investment Management founder Ross Margolies told the audience, "If someone is making double digit returns, I don't' think they're caring if they are paying one to two percent. If someone is making three percent, one or two percent is a lot of money."

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