Hedge fund assets soared to record levels during the third-quarter, but at their current pace, inflows are on track for their weakest performance since 2009, when investors were either cashing out, or turning to less risky assets.
Hedge Fund Research Inc. noted that during the third-quarter , hedge fund assets climbed 3.6 percent to $2.19 trillion, with investors continuing to show a strong preference for fixed-income based relative value arbitrage strategies.
As usual, investors overwhelmingly preferred to cast their lot with established firms, with more than $13 billion of the total third-quarter inflow going to hedge funds with at least $5 billion in assets under management, HFR said.
But the interesting thing about these third-quarter figures is whom hedge funds are working for these days. Most of the inflow now is coming from institutional investors like pension funds, and not the rich, individual investors who used to be the industry's bread and butter.
However Reuters points out that by taking on so many institutional investors, hedge funds - particularly the larger firms - are limited in taking the sorts of risks that are necessary to generate double digit annual returns. Slow and steady is what the institutional community is after, and for the most part that's just what hedge funds have delivered over the last decade.
HFR data shows the average fund has earned 6.77 percent for investors over the past 10 years. In the last five however, the numbers become downright mediocre, with HFR noting that the average fund has brought in 1.44 percent during that timeframe.
And of course, this is all a major turnoff for the rich.
"High net worth investors went into hedge funds in many cases because they personally knew the manager, they wanted significant returns and weren't hugely concerned with monthly numbers or volatility," Anita Nemes, Global Head of Capital Introduction at Deutsche Bank, said.
"Institutional investors want uncorrelated returns and low volatility from hedge funds. (They) want different things."
Like Matthew 6:24 says, "No one can serve two masters." So as larger hedge funds become more institutional and mainstream, the rich are looking elsewhere for large returns.
Instead of hedge funds, many of the private investors are putting their millions into private equity, old-fashioned long-only stock pickers or even property or fine wine, which have often outperformed hedge funds since the 2008 financial crisis.
Should the Rich Go Small?
In spite of the less than stellar returns hedge funds have generated of late, it's still a bit shortsighted for the rich to completely write them off as an investment. Rather than looking to invest in larger, established hedge funds, data from PerTrac suggests they should turn to the smaller players.
In a study of hedge fund performance between 1996 and 2011, PerTrac found that although large funds were better able to withstand down years like 2008 or 2011, small funds generally outperformed large and mid-sized hedge funds during that 15 year period.
PerTrac defined a small hedge fund as a firm with $100 million or less in assets, while a large hedge fund had $500 million or more in AUM.
"Investors with a higher volatility appetite and seeking to maximize their returns should examine funds with less than $100 million in AUM, since the average small fund has outperformed the average mid-size fund and average large fund in 13 out of the last 16 years," PerTrac said.