Hedge Fund Consistency Isn't The Point

A surge of investors may need to rethink expectations

Hedge funds offer investors a range of appealing ingredients. Diversificaton. Big returns. Limited downside. How about consistency?

Hedge fund data provider Preqin this week published league tables showing which hedge funds were the most consistent across a range of different strategies. The report ranked the performance of 1,761 funds over the three years to the end of 2015. Preqin said the results (which you can see here) aren't meant to endorse any fund "but rather to illustrate those that have performed the most consistently over the period."

So far, so useful. But leave aside any concerns about who came out on top and questions on how the methodology works (one issue is the relative lack of volatility over two of the three years studied, another is whether three years is the right amount of time in the first place). The report raises an important question: How much should hedge fund investors be looking for consistency in the first place?

Show Me The Money

Institutional investors said performance was the key issue facing hedge funds in 2016

Source: Preqin

Nobody is going to complain about a regular stream of outsized returns from their investment. But it's the outsized bit of that sentence that matters.  The typical fee structure is an eyewatering 2 and 20 -- an annual 2 percent fee plus 20 percent of any profit.

That structure is under pressure, but it's still typical, because it reflects the potential for significant upside. That's also why most major investors would allocate only a small proportion of their overall portfolio to this asset class. Steadiness doesn't figure into it.

This point may have got lost in recent years. The hedge fund industry has grown sharply since the financial crisis, more or less doubling in terms of assets under management since 2008. A rough start to 2016 in financial markets has hit the sector, but overall, it is still far bigger than just a few years ago.

At the same time, hedge funds on the whole have struggled to outperform other asset classes, in part because of loose monetary policy around the world. It's not hard to imagine that some investors are disappointed -- indeed another Preqin survey found a third of hedge fund investors said their return expectations were not met in 2015.

Hedge Fund Growth

The industry is twice the size it was in 2008

Source: Hedge Fund Research

Naturally, this means two thirds were satisfied. But among those who weren't, some are likely dealing with genuinely poor performance, while others, it's fairly safe to assume, may have had unrealistic expectations in the first place. Investors who bought into hedge funds looking for a steady-as-she-goes asset class will likely be among them.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Duncan Mavin in London at dmavin@bloomberg.net

    To contact the editor responsible for this story:
    Jennifer Ryan at jryan13@bloomberg.net

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