ARLINGTON, VA, September 28, 2022 – Hedge funds have provided strong downside management in the ongoing bear market — as a proportion of broader market falls — since the dot-com crash at the turn of the 21st century, according to new research from WTW (NASDAQ: WTW).
The research found that hedge funds have delivered downside management with returns of –5.6% between January and June 2022 (on the HFRI Fund Weighted Composite Index) compared with broader equity market declines of –20.5% on the MSCI World Index.
This means that hedge funds have tracked just over one-quarter (27% proportion) of broader market declines over this period. This compares favorably with the initial pandemic panic seen in markets in early 2020, when a –11.6% drop from hedge funds matched more than half of the –21.1% drop in equities over the same bear market period (January to March 2020).
Today’s downside management is not as strong as was seen in the dot-com crash when hedge funds almost avoided a negative return while markets fell by nearly half; however, the current performance offers a striking parallel to the downside management seen from hedge funds during the early 1990s, when the invasion of Kuwait caused an oil shock, a recession in many economies and an associated bear market.
This serves as a reminder of the potentially powerful role of hedge funds in portfolios, particularly in today’s market conditions of high inflation, a challenged macroeconomic outlook and the ongoing Russia-Ukraine war.
Today’s newly released research paper from WTW highlights positive changes to the hedge fund industry in recent years. These trends include technological and investment innovation, momentum in sustainable investing best practices and delivery of better value for money.
“Sustained change will be essential for hedge funds to stay relevant. A hedge fund industry offering a strong client value proposition can thrive in these uncertain times,” said Chris Redmond, head of Manager Research at WTW.
“Our mission to change the investment industry for the benefit of the end saver has driven us to create a new way for hedge funds. We are encouraged by the value added by those hedge funds that have embraced this and by the emerging positive trends we have examined in our recent papers. We believe that in the current environment, hedge funds are well positioned to contribute strongly to institutional investors’ portfolios, as evidenced by their recent robust performance.”
“We are convinced that by embracing innovation and sustainable investing best practices, the hedge fund industry can take a leap forward in its client value proposition, establishing a sector that will better reflect our society and deliver better performance outcomes for savers.”
“However, there is a risk that the recent improvements in performance outcomes and renewed interest catalyses a backward step to some of the ugly behaviors of the past; we hope this will not be the case,” concluded Redmond.
Hedge Funds: The Industry Strikes Back leverages the data insights obtained over the past three years to demonstrate that the portfolios of hedge funds constructed using “a new way” have consistently added value. Not only have hedge funds generated stronger absolute returns than WTW has seen over the past two decades, but they have also offered significant protection at times of volatility.
This year’s downside management from hedge funds has beaten the industry’s performance during the financial crisis of 2007 to 2009, when hedge funds (down –21.4% between November 2007 and February 2009) tracked two-fifths of the drop in equity markets (down –54.0% in the same financial crisis bear market).
A newer industry evolution is the growth in multi-manager platform hedge funds (known as platforms), a hedge fund product type that employs multiple portfolio managers under the same hedge fund roof with all costs passed through to the underlying investors. Due to relatively robust return potential and consistent marketing efforts, many of the industry’s hedge fund platform solutions are seeing growth in assets under management. This success is typically enticing more hedge funds to switch to this business model, which, WTW warns, would denote a backward step for the industry and risks disenfranchising the end saver, representing a departure from a value-for-money mindset.
To prevent this, WTW highlights the areas where more remains to be done to encourage more asset owners to tap into hedge funds’ full potential and seek to generate better returns. To firmly set the wider hedge fund industry on a positive trajectory, WTW suggests:
Today’s paper follows WTW’s prior 2019 research, Hedge funds: A new way, which took a contrarian stance during the peak of hedge fund unpopularity by calling attention to the potential benefits of investing in hedge funds.
According to Redmond, “We have been encouraged by the progress made by the hedge fund industry in recent years, including the strong performance contributions to institutional investors’ portfolios and downside management provided in periods of falling equity markets. There is a fantastic opportunity for hedge funds to continue recent positive momentum and remain highly relevant to investors; however, there is a risk that the recent success catalyzes a backward step, with expense pass-through models employed by platforms a potential example. We question whether clients are getting value for money from this platform model and worry about the misalignment of interest with the end saver.”
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