Outflows, underperformance, and liquidations: Hedge funds have not enjoyed 2019

Spencer Platt/Getty Images

A man pauses outside of the New York Stock Exchange (NYSE) on January 15, 2016 in New York City.

• Hedge funds got out to a roaring start in 2019, but have slipped since, with the average fund underperforming the overall market.
• Investors, many of whom put up with net losses in their hedge fund portfolios last year, have been pulling money by the billions.
• More hedge funds were liquidated than launched in the first quarter of the year, the third quarter in a row that has happened, and this year has lacked the mega-launches that dominated last year's headlines.
• Click here for BI Prime stories.

The $3.2 trillion hedge fund industry is not having a good time.

While investors going into the year were optimistic about their hedge fund portfolios, the industry's underperformance - returning 5.3% on average through May compared to the S&P returning nearly 10% during the same time - has led to more $25 billion in redemptions, according to data tracker eVestment.

These poor returns have coincided with investor demand for lower fees and increased transparency, simultaneously pushing long-time players out of the space while raising the bar for new entrants.

"The industry is enduring a consolidation drive primarily by the ability, or inability, of managers to produce returns in-line with investor expectations," a report by eVestment reads.

Aspiring hedge fund founders have not been encouraged to try their hand as more hedge funds were liquidated in the first quarter than launched, according to Hedge Fund Research. It was the third straight quarter the total number of funds have declined.

See more: JPMorgan's Highbridge Capital is unwinding a $2 billion fund and now turning to investor demand for credit

Unlike last year, 2019 has not matched big-name liquidations with big-name launches. Billionaire David Tepper is returning outside capital as he shifts his well-known hedge fund, Appaloosa, into a family office. However, there are no launches yet scheduled for this year to match the assets or hype of Michael Gelband's ExodusPoint or Daniel Sundheim's D1 Capital Partners going live last year.

So far, the biggest expected launches this year are coming from Citadel alumni, like Jack Woodruff, Mike Rockefeller, and John Graham, the biggest of which - Woodruff and Rockefeller's Woodline Capital - is expected to launch with roughly $1 billion. Last year, Gelband set the record for the biggest launch with $8 billion.

For new launches to be successful, significant day one assets are needed, even for managers with the best connections. A recent report by Goldman Sachs' prime brokerage desk found that hedge funds with less than $250 million had less than a 50-50 chance of surviving their first three years of trading. Meanwhile, those that start with more than $1 billion in assets are able to make it past the three-year mark 84% of the time.

See more: A $10.5 billion fund at Canyon Partners has loaded up on cash amid a shaky stock market

Still, industry giants expect the ongoing consolidation to continue. Billionaire Stan Druckenmiller said that there's only five to 10 people worth the fees hedge funds charge, and Oaktree Capital founder Howard Marks believes young investors don't have the same opportunities to start funds like he and others did decades ago.

"We need to get to back 200 or 300" funds, Druckenmiller said at a New York Economic Club event last month.

See more: Inside the hellacious hedge fund money-raising environment, where 'even the big funds have to get creative'