Institutional investors still like to invest in hedge funds but they are less enthusiastic about them right now and holding back allocations to those strategies until next year, according to Preqin’s latest investor outlook report based on a June survey of 185 institutions.
Seven percent of public pension assets and 18 percent of large endowment assets are invested in hedge funds for their diversification, low correlation to other asset classes, and risk-adjusted returns. Diversification was especially important; 68 percent of institutions surveyed said it was the top reason to invest in hedge funds, a greater number than those who said the same about private equity (60 percent), venture capital (59 percent), and private debt (57 percent).
Nearly half of the institutions also said that hedge funds’ low correlation to other asset classes was appealing. That was a higher percentage than what respondents said about other asset classes.
Institutions aren’t turning to hedge funds to protect their portfolios against inflation, a huge worry for investors in recent years. Only 7 percent of them considered the strategies as an inflation hedge, similar to private equity (6 percent) and VC (4 percent). (If the Fed cuts its interest rate target this fall, the drop in rates may be a tailwind to the stock market and good for hedge funds.)
Even so, institutions are planning to invest less in hedge funds this year. “Their confidence in these allocations meeting those goals is wavering,” according to the Preqin report.
This summer, 18 percent of institutions said they planned to keep their current hedge fund positions, 47 percent planned to keep their allocations. But 35 percent planned to decrease their allocations, up from 25 percent last year. The proportion stating they would hold steady in their hedge funds positions was unchanged compared to last year, meaning institutional investor attitudes about hedge funds have meaningfully shifted. The mood shift was also evident in asset flows. There were $25.2 billion in net redemptions from hedge funds between March 2023 and March 2024, according to Preqin.
Critics argue that investors are basing their allocations on flawed data. Most hedge funds above $1 billion in assets don’t share their data to the commercial databases. But without these funds, hedge fund performance looks dismal. Once these hedge funds are added to the data set, average performance rises by more than two percentage points.
Even the institutional investors that plan on allocating more to hedge funds aren’t doing it soon — 68 percent are defering those decisions until next year and 40 percent do not plan to put new money into hedge funds until the second half of 2025 or later. Right now, inventors have a major “wait-and-see approach,” the report said.