Hedge funds — once synonymous with glamour, win-at-all-costs alpha males and bold market bets — are losing their appeal among wealthy investors, who question whether the traditionally pricey products are worth the cost.
Indeed, leading advisers have cut their clients' allocations to such funds by as much as a third over the past year, FT research shows.
Last year hedge funds mustered less than half the 11.9 per cent return of the S&P 500, according to an index of more than 2,000 hedge funds, put together by HFR, a research company. It was the ninth consecutive calendar year that hedge funds underperformed the stock market when their fees were taken into account.
Investors clawed back $110bn from hedge funds last year and further withdrawals in the past six months have left the industry at around $3.1tn, according to eVestment, which tracks fund flows. Adviser companies in the FT 300 this year reported reducing the amount allocated to hedge funds to 2 per cent, down from 3.2 per cent in 2016.
"Hedge funds had a mystique about them that they could perform in any market but what everybody's seen is they're not immune," says Paul Karger, managing partner of TwinFocus Capital, an investment adviser overseeing $4.5bn for wealthy individuals that features in this year's FT 300 ranking.
Recent performance has also unravelled the commonly held belief that hedge funds act as a counterweight in periods of poor stock market returns, he adds. "The problem is these hedge funds haven't been able to perform in any environment."
TwinFocus retains client assets in specialised hedge funds but has pulled money from traditional equity-based strategies that Mr Karger says have not lived up to their cost.
"I think fees are a big driver of dollars coming out — investors are voting with their feet," says Jeremy Beal, head of alternative investments for Morgan Stanley Wealth Management, the US bank's brokerage.
He disagrees with Mr Karger's assessment that hedge funds fail to offer uncorrelated returns to the stock market and believes they will maintain a role in wealthy investors' portfolios.
The last year hedge funds outperformed the stock market was 2008 during the financial crisis, when they shed 19 per cent compared with the S&P 500's 37 per cent loss, according to HFR data.
Hedge funds have dropped fees and the minimum amounts clients can invest, offering wealthy individuals an easier point of entry. Notable companies that trimmed fees last year include Tudor Investment and Och-Ziff Capital Management.
"Now we have access to these at relatively low minimums, the value proposition and being able to pick and choose becomes more attractive," says Mr Beal. "Hedge funds have a critical place in the portfolio in terms of providing diversification and non-correlation and should be looked at in the aggregate of a portfolio."
Aside from lower fees, some hedge funds are trying to tempt investors with greater liquidity. Funds are offering their strategies through a broader set of investment vehicles, giving investors the ability to pull — or add — assets more frequently.
The traditional hedge fund model involved locking up assets for five to 10 years and giving money managers free rein to deliver returns. Now investors can enter strategies in a form akin to mutual funds, known as "liquid alts", offering the ability to enter or exit on a monthly or quarterly basis.
"The key thing for clients is liquidity, then transparency," says George Padula, who helps manage $2bn in client assets for Modera Wealth Management, an FT 300 investment adviser. But liquidity brings drawbacks.
Hedge fund managers are more restricted in the ways they can use capital in a liquid vehicle, which ultimately hurts performance.
Individual investors also demand greater insight into the inner workings of a hedge fund's strategy, which can be irksome for managers who are reluctant to share their ideas.
"The ability to have transparency is critical — not too many people are willing these days to say, 'I'll trust your methodology'. They want to dig deeper and understand what's under the hood," says Mr Padula.
Hedge funds are one category among several types of alternative investments that broadly include anything that is not a stock or bond. Within this broader grouping, individual investors are gaining easier access to previously unattainable investments, such as private equity and real estate, which used to be accessible only via large commitments.
Financial advisers and their clients are considering these types of investments instead of hedge funds, says Joe Moran, a sales executive who works with financial advisers for BNY Mellon Investment Management, a unit of the US bank.
Private credit — a growing industry that converts investor capital into business lending — as well as private equity and real estate offer wealthy investors attractive yields compared to hedge funds' recent spotty performance, says Mr Moran.