Fed up with steep fees for pitiful performance, investors are pulling billions from hedge funds

Up in smoke.
Up in smoke.
Image: Reuters/Damir Sagolj
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Investors in hedge funds have had enough. These funds charge notoriously high fees to manage their money, but have performed dismally in relation to low-cost alternatives. As a result, global investors have pulled $56 billion from hedge funds in the first seven months of 2016, according to consultancy eVestment.

In July alone, investors pulled more than $25 billion from the funds, the largest monthly redemption since the depths of the global financial crisis in early 2009. “Investor redemptions from the industry continue to be driven by mediocre performance,” eVestment said. “Funds producing losses in 2015 are by far the primary source of outflows throughout the year into July.”

On average, global hedge funds returned 1.5% in July, according to Hedge Fund Research, hardly something to celebrate when the S&P 500 rose by 3.7% over the same period. Amid anxiety about low interest rates, high valuations, and the sustainability of future returns, this underperformance is not taken lightly.

Moonir Kazi is a director at PricewaterhouseCoopers who advises hedge funds on tax, regulation, and strategy. He says the feeling among investors is this: “We can’t continue, we’ve done three to six months of waiting and holding on and trying to be optimistic. And now it’s the second half of the year, we have to start thinking about the year-end very soon and we can’t hold on forever.”

Steve Eisman, the investor who was featured in Michael Lewis’ book The Big Short (played by Steve Carell in the movie), is betting that hedge funds will have to slash their exorbitant fees to something like his firm’s flat charge of 1.25% of assets. Traditionally, hedge funds levy a 2% annual fee on assets in addition to 20% of any profit they generate.

Justifying these charges is becoming progressively difficult, as hedge funds persistently underperform broad indexes that investors can buy via mutual funds with next to nothing in fees.

The investment industry in general is seeing a shift from actively managed funds to cheaper, passive options. For example, flows into exchange-traded funds have surged, with US-listed ETFs recording $53 billion of net inflows in July, a sharp contrast to shrinking hedge funds. Tudor Investment, one of the oldest hedge funds, recently cut 15% of its workforce and reduced fees.

Eroding confidence in hedge funds has been building for the past year, says Pavle Sabic of S&P Global Market Intelligence. With many ETFs outperforming supposedly sophisticated hedge funds, while often charging just 0.3% of assets per year, it’s easy to see why. “I suspect investors are increasingly looking elsewhere for gains,” he says.