What will the next five years bring for hedge funds? A Billion dollar question I’ll try to answer in this article
1. More the greatest class?
I expect the hedge fund sector to grow by 31% over the next five years to reach USD 4,700 billion in 2023. Even if it is the percentage, it is the smallest anticipated increase of all alternative asset classes. At $1.1 trillion, it follows the second highest level of expected net capital growth, behind private equity alone ($1,800 billion), which should outperform hedge funds as the largest alternative sector, at $4,900 billion.
2. No more exposure to illiquid strategies
Among the private equity investors surveyed, 79% expect to increase their private equity allocations by 2023, but only 27% of hedge fund investors expect to do the same with hedge funds. Indeed, 16% plan to reduce their hedge fund allocations. Although the expected growth is not particularly high, the percentage to reduce their allocations is not either. As such, we expect steady growth, as most of them expect to maintain their exposure to hedge funds relatively stable, which confirms the trend observed in recent years.
3. Modest growth in hedge fund allocations: not all bad news
Given the high returns and record distributions in the private equity sector, it is not surprising that investors are beginning to shift to illiquid alternatives in an attempt to further diversify their portfolios and build more sophisticated ones. However, the relatively modest growth forecasts for hedge fund allocations may not be as unfavourable for the sector as the survey results suggest.
Over the past decade or so, more and more investors have built increasingly large hedge fund portfolios, with generally greater exposure to hedge funds than to private equity assets. For example, private equity investors generally invest between 9% and 10% of their portfolios in the asset class, compared to 14% to 15% for the average investor in hedge funds. Although we expect hedge fund allocations to remain relatively static between many institutional groups, activity will likely be significant as investors continue to buy back and rebalance their assets in line with market conditions and tactical objectives.
4. Private wealth: coming back?
When asked about the types of investors active in this sector, 76% of hedge fund managers surveyed expect an increase in the share of capital from institutions. In particular, the largest cohort (66%) of respondents believe that family offices will be more valuable sources of capital, followed by 52% of foundations and 46% of sovereign and endowment funds. These figures compare respectively with 38% and 36% for private and public pension funds.
When we consider the origins of private wealth in the hedge fund sector, the capital of wealthy individuals and families was essential. It is therefore interesting to observe how the industry seems to be closing the loop. After 15 years of growth driven by institutional capital, the rich of this region are now expected to return to growth. To attract this capital, managers may have to adapt their product offerings to the different needs of these investors.
What does all this mean for hedge fund managers?
Despite the rapid growth in the number of managers after the crisis, the total number of active hedge funds has reached a plateau since 2016. This coincides with a dramatic drop in the number of new hedge fund managers entering the sector each year and in each region. There are approximately 14,800 active hedge funds today, a figure that has remained stable since the end of 2017 and remains relatively unchanged compared to the end of 2015. What will happen to this total in the next five years? Managers are largely united in the belief that there will be further consolidation in the industry by 2023, according to 91% of respondents, 26% of whom anticipate significant levels of consolidation. This is the highest proportion of all alternative asset classes.
Consolidation and challenges are to come.
If my expectations are met, the number of active hedge funds will stabilize or decrease slightly over the next five years. As the investor ecosystem evolves into something more and more complex, so will the demands of these investors. We therefore believe that the future environment will pose significant challenges for hedge fund managers and that only those who can prove their value to investors and adapt to their ever-changing demands will survive.
Despite the difficulties encountered, more and more non-American investors are joining.
As a region, North America is the main source of capital for hedge funds, but 42% of respondents in our study believe that the share of capital held by North American investors will decrease over the next five years as investors in other regions increase their exposure to hedge funds. By comparison, 64% and 59% expect an increase in investors’ share of capital in Europe and Asia-Pacific by 2023. Among emerging markets, the majority of managers expect an increase in capital from the Middle East (37%). %) and China (29%).
How hedge fund managers adapt and evolve to meet the needs of a (likely) very different investor base will (most likely) determine their success and longevity. Many can open local offices to host a more dynamic pool of investors at the regional level, expand their product range or invest in new technologies and approaches.
And technology can provide answers.
With respect to artificial intelligence (AI) and automatic learning, 88% of managers surveyed expect these strategies to become more important in the industry in 2023. When asked which sector of their company can benefit from technological advances, the largest proportion (65%) of hedge fund managers mentioned fund operations. The measurement of the impact and lifetime of new technologies – such as blockchain, crypto-currencies, big data and artificial intelligence/automatic learning – remains to be demonstrated, but it is generally accepted that these developments will improve the efficiency of the search for alpha sources and reduce costs.
Whatever the field, whatever the choice of managers, it is the act of evolution that will make all the difference. The history of hedge funds is proof that a lot can change in just five years.