Hedge funds are getting hit by a double whammy of declining performance and fed-up investors pulling their money.
While the first problem may be a function of short-term market troubles, the second problem may be the result of a structural shift, according to some investors.
“You’ve seen some of the California pensions, some New York pensions, and even today MetLife said they are walking out of a $1.8 billion hedge fund allocation,” Michael Gregory, chief investment officer at Highland Alternative Investors, a division of the firm Highland Capital Management, told Business Insider on Thursday.
Part of this is related to the fact that funds are losing money, but Gregory and Mark Okada, Highland’s cofounder and chief investment officer, say a shift is taking place that is about more than just performance.
It comes down to two things: fees and flexibility.
Gregory highlighted the impact of fees on investors’ decisions.
“If you’re a [low volatility] equity fund and you’re generating mid- to high-single digits but charging 2% base fee and 20% carry, for a pension that’s not very attractive,” Gregory said.
Instead of paying high fees for a hedge fund, some individual and institutional investors are turning to liquid alternatives funds.
Liquid alt funds are similar to hedge funds in the sense that they try to outperform the broader market using strategies such as shorting and leverage, but they charge much lower fees and allow investors to move money in and out of the fund on a daily basis.
Traditional hedge funds usually have so-called lock-up periods that force investors to wait before withdrawing money.
Combine the lower fees with this flexibility, and liquid alts can look like an enticing option.
“I see liquid alts disrupting the hedge fund industry over the next 15 years,” Okada said.
These strategies doubled assets from 2010 to 2014 but faced some outflows last year. Still, liquid alt funds outperformed hedge funds in 2015, according to Goldman Sachs.
“We’ve been slowly spending a lot of time in this area,” Okada said, “and it’s a lot of hard work to educate investors, to have the right products, to get the risk management right, to get the distribution right, but you can have a transparent, low fee, daily liquidity mousetrap.
“If you can do that, and there are a lot of ifs, why you would ever go into a hedge fund vehicle?”
Gregory did suggest that there was a time and a place for hedge funds, saying that sometimes a fund with a longer time horizon can work.
“We think that extrapolation of short periods and indicting the whole hedge fund industry is a bad move,” Gregory said.
Okada, however, summed up the shift using a comparison to another high-profile, and successful, disrupter.
“I think this is disruptive, just like Uber is disruptive to cab drivers,” he said. “I think it is very disruptive, and the establishment is pushing back.”
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