In the ongoing bear market, hedge funds have provided their best downside protection as a proportion of broader market falls since the dotcom crash at the turn of the 21st century.
- Hedge funds are providing their best downside protection since 2002, as a proportion of equity market falls
- Over the past three years hedge funds have generated stronger average absolute returns than seen in the past two decades
- Multi-manager platforms are seeing significant growth in AUM but their ‘pass-through’ cost model risks disenfranchising investors
In the ongoing bear market, hedge funds have provided their best downside protection as a proportion of broader market falls since the dotcom crash at the turn of the 21st century.
According to new research from investment solution provider, WTW (formerly Willis Towers Watson), hedge funds have delivered downside protection with returns of -5.6% between January and June 2022 (on the HFRI Fund Weighted Composite index) compared to 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 favourably to 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 – March 2020).
Current downside protection is not as strong as was seen in the Dotcom crash when hedge funds almost avoided a negative return while markets fell by nearly half. However, recent performance offers a striking parallel to the downside protection seen from hedge funds during the early 1990s, when the invasion of Kuwait caused an oil shock, recession in many economies, and associated bear market.
WTW’s latest research paper – Hedge Funds: The industry strikes back – also 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 delivering better value for money.
The paper leverages the data insights obtained over the last 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 protection from hedge funds has beaten the industry’s performance during the financial crisis of 2007-2009, 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 (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 performance and consistent marketing efforts, many of the industry’s hedge fund platform solutions are seeing significant growth in assets under management. This success is 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 has highlighted the areas where more remains to be done to encourage more asset owners to tap into hedge funds’ full potential and generate better returns. In order to firmly set the wider hedge fund industry on a positive trajectory, WTW suggests that hedge funds make Inclusion and Diversity an urgent priority in order to attract and retain talent, while keeping the industry relevant and at its best for investors.
In addition, investors allocating to hedge funds using the expense pass-through model should check whether they are getting value for money and protecting the longer-term stability of this model.
The hedge fund industry meanwhile should prioritise providing better alignment of fees, expenses and terms with investors and seek to improve their client value proposition.
Key Takeaway: Investors | Relatively robust performance has boosted the profile and AUM of multi-manager platforms, but investors may not be best served by their ‘pass-through’ expenses model
