Hedge funds, once Wall Street favorites in the 1990s and early 2000s, faced skeptics by 2018 due to declining efficiency. Yet, their strong performance during the 2020 financial crisis reignited interest, begging the question about their longevity and relevance in the next decade.
Upon examining hedge funds, it's critical to note their varying definitions. The Securities and Exchange Commission (SEC) does not offer a strict definition, while the International Monetary Fund (IMF) associates hedge funds with four elements: absolute returns, hedging, arbitrage, and leveraging. Wide use of these elements among successful investment vehicles suggests the fundamental strategy of hedge funds remains resilient.
Hedge funds today typically share a few traits: private organization style, high-net-worth individuals (HNWIs) and institutional investors in their client base, and less regulatory scrutiny. Despite shifts in the financial landscape, traditional hedge fund management from the 80s and 90s adapts to survive.
However, investor inclination towards hedge funds reportedly decreased for three consecutive years till 2020, with allocations dropping from 40% in 2018 to 23% in 2020 according to EY. The decline might be attributed to other investment categories like private equity, real estate and credit outshining hedge funds. Despite this, hedge funds showcased compelling performance during the 2020 crisis, with projections of a resurgence in active hedge fund management in volatile scenarios.
The pandemic transformed hedge fund operations, pushing towards increased reliance on technology, automation, digitalization, and outsourcing. Encouragingly, investments in environment, social, and governance (ESG) aspects doubled over the previous year, highlighting a growing interest in solving prevalent societal issues. However, improving ethnic and gender diversity remains low on the agenda for most hedge fund managers.
The democratization of investing online, another trend buoyed by the pandemic, disrupted traditional hedge fund betting strategies. This was visible in the rise of meme stocks and crypto tokens, attracting investments contrary to hedge fund shorts.
From a ten-year perspective, hedge funds show indications of adaptability and resilience. They may focus more on sustainability, climate change, and social concerns and increasingly harness technology to achieve more efficiency. Furthermore, restrictions on hedge fund investment may ease, enabling more accessibility with certain funds already lowering minimum investment thresholds.
Research agency Prequin predicts that global alternative assets will remain the second-largest alternative asset class after private equity, hitting $4.3 trillion by 2025. They consider hedge fund risk mitigation strategies to have proven their worth during the pandemic. The CFA Society of New York echoed similar sentiments stating that hedge funds offer exclusive and valuable access to returns and strategies not typically accessible via traditional structures. These characteristics make hedge funds an increasingly sought-after addition to traditional portfolios.