Investors are hot on hedge funds again, but old-school stock pickers are getting left in the cold
- Despite coming off one of the worst performing years on record, hedge funds are enjoying renewed interest from investors, who believe there is a market slowdown coming, a JPMorgan survey finds.
- But the one type of fund that hasn't seen a surge in interest is the one that the industry was built on: fundamental long-short equity.
- Investors prefer to get equity exposure in their hedge fund portfolios through quant strategies, the survey shows, and managers like Jana Partners and BlueMountain Capital have already cut back on their stock-picking products this year.
The hedge fund industry's exponential growth over the last couple of decades can be at least partially be attributed to the near-mythological status that the early top stock-pickers enjoyed among investors.
Tens of billions poured into these funds and their spin-offs, as investors trusted investors like Tiger Management founder Julian Robertson to win big bets in the stock market.
Now, investors are turning to machines over people for their stock hit, and asking hedge funds still run by humans for strategies that can't be replicated by a computer.
Despite bounce-back performances from well-known stock-pickers like David Einhorn and Bill Ackman this year, money has flowed out of these funds faster than any other category - bleeding more than $6 billion through February, while the overall industry is up $1.6 billion, according to eVestment. Last year, the category saw $10.7 billion leave in net redemptions.
For the remainder of 2019, investors want to increase their investments in the hedge fund space, a survey of JPMorgan's institutional investor clients shows, but for equity strategies, quants are preferred, as investors favor the transparent and unemotional way they invest.
Only 13% of investors in J.P. Morgan survey want to decrease their allocations to hedge funds this year, while 32% plan to increase - primarily because they see a slowdown coming in the markets, and want to build up a hedge against it in their portfolios. A new Preqin study similarly found that 61% of institutions believe equity markets are "at their peak."
Old-school stockpickers, who are supposed to protect against market downturns with their short positions, will not have nearly as many investors fighting to invest more with them this year, according to JPMorgan. Nearly a third of investors, on an asset-weighted basis, plan to decrease their stock-picking allocations this year, compared to only 10% that plan to increase it.
"Beta has been cheap and effective for the past decade," said Michael Monforth, global head of JPMorgan's capital introductory group, about why investors no longer want many large funds' bread-and-butter strategy. The challenge many funds have had in making money on their shorts has also convinced investors to either move their hedge fund money out of equities entirely or into quant funds.
Managers have responded already in 2019. Jana Partners closed its stock-picking fund to focus on its activism efforts, and BlueMountain Capital Management cut its long-short fund after just two years of trading.
Quant equity funds are still a hot commodity in investors' eyes, and 21% plan to increase their allocation to computer-controlled funds compared to just 6% decreasing. Strategies that are "agnostic to the markets" can also expect to pick up assets from people leaving stock-picking funds, said Monforth.
At Aberdeen Standard, the firm's clients have interest in more complex hedge fund strategies, such as private debt, because it is hard to replicate with an algorithm or factors, said Darren Levy, head of alternative investment strategies for the Americas at Aberdeen.
"There's a high barrier to entry in those fields, unlike long-short equity, because in alternative credit you need higher starting capital, trading relationships, infrastructure, and more to pull off these types of securities and investments," he said.
Multi-strategy behemoths like Point72 or Citadel built around their long-short strategies can take solace in the fact that investors are interested in staying with managers they have already been working with, according to Monforth. Investors are not leaving the hedge fund industry because they are frustrated with a stock-picking strategy, he said.
"You don't sell your car if you have a flat tire, you fix the flat tire," he said. "It's like going with the manager you know, because there's already a relationship there, and investors can potentially push for more transparency or a better fee structure by staying at the same manager."