In the February issue of its Hedge Fund Spotlight, Preqin looks into its crystal ball and tells us of its near term (2017) predictions for the hedge fund industry.

The article begins with a simple observation: hedge funds saw net outflows of assets under management (AUM) in 2016. Likewise, 54% of all funds considered individually recorded net outflows of their own. Both credit and equity strategies sustained such outflows, although commodity trading advisors bucked the trend and saw net inflows.

All this raises an obvious predictive question: will 2017 also be a down year for AUM?

Investor Pullbacks versus Managerial ‘Animal Spirits’

Among the investors Preqin surveyed at the end of 2016, more intended to reduce than to increase their allocations to hedge funds. This is the second year that has been so.

Preqin’s prediction? It strongly suggests, largely on the basis of that survey, that this year will be another net outflow year. What is more, “[W]e may even see larger outflows over the forthcoming year than those reported in 2016.”

Among the fund managers surveyed, opinion was starkly divided on this question. There is no majority opinion. Although the largest number (40%) say that hedge fund industry assets will increase over the course of this year, a close-to-equal number, 36%, say that assets will decrease, leaving a considerable number (23%) in the  stay-the-same camp.

Managing a hedge fund requires a considerable supply of what old-fashioned economists called “animal spirits,” an adrenaline fueled combination of optimistic outlook and make-it-happen determination. Given that innate bias, it is no surprise that a large number believe their industry will increase its AUM this year. The surprise, which may also be a warning, is that the percentage by which they believe this is not larger than it is, and is well short of a majority.

CTAs versus Relative Value HFs

The second subject the report broaches is: which strategies specifically will do better (again as measured by AUM growth or decline) than which others?  Will CTA’s again manage to buck the downward trend and show overall inflow?

In a word: No. CTA’s will likely be down in 2017. Twice as many investors in this strategy plan to reduce their allocation then plan to increase it, the Preqin survey indicates. The performance of such advisors last year justifies such a pullback. It was less than thrilling: the relevant benchmark returned just 0.91% in 2016.

One space that looks ready to expand: the AUM of hedge funds pursuing a relative value strategy (that is, pursuing the exploitation of the prices or rates of different-but-similar securities).

More than a quarter (26%) of those investors who do have some exposure to the relative value strategy plan to increase that exposure this year. Meanwhile, only 6% of investors in that position plan to cut their exposure in this field back.

At the same time, there aren’t a lot of planned launches of new relative value funds that would be in a position to take advantage of this sentiment. The strategy accounts for just 5% of planned launches, the lowest percentage of any strategy included in the survey. So presumably those already engaged in the field will have the new AUM, generated by investor interest, largely to themselves.

With regard to projected launches for other strategies, equity and credit strategies predominate, representing 26% each of the new launches. There are only a few macro fund launches in the works for this year, 7% of the whole.

Performance and Fees

Another Preqin prediction for 2017, one that seems fairly ‘safe’ on its face, is that performance and fees will remain ‘key issues’ between the investors and the managers of hedge funds. The question of whether fees are structured so as to align the interests of managers with those of their investors has long been a contentious one, and no one expects that subject of contention simply to fade away, this year or any other year soon!

But the article in Spotlight manages to add an optimistic gloss here. The contention remains, but the investors believe they are making headway.

“Significant levels of investors believe that their interests are not aligned with those of their fund managers. However, the majority (58%) of investors reported that they had seen an improvement in their favour in the terms and conditions charged by their fund managers over the course of 2016,” the article says.