Investors rekindle love affair with hedge funds

To get back into investors' good graces, funds have had to alter traits like their liquidity, fees — even their overall structure.

Investors are back to loving hedge funds, if you can still call them that.

Net demand for allocating to hedge funds is the highest in at least three years at 28%, compared with 12% a year prior, according to a Credit Suisse Group AG survey released Tuesday. That ranks them only 1 percentage point behind private equity among the top alternative asset classes.

It’s a vindication of sorts for the roughly $3 trillion industry, which after years of mediocre performance may benefit from rising interest rates and volatility returning to global markets. But to get back into investors’ good graces, funds have had to alter traits like their liquidity, fees, even their overall structure. For the first time, the survey found greater demand for unconventional hedge-fund offerings than for even their top traditional strategy.

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“As investors start to look at hedge funds in terms of their broader portfolio, they’re using or employing more-customized solutions via managed accounts and nontraditional structures where they’re assessing hedge funds in numerous ways to fulfill their needs and objectives,” said Joseph Gasparro, who leads strategic advisory and content for Credit Suisse Capital Services.

Among traditional strategies investors are still demanding, those focused on macroeconomic trends and health-care stocks topped the list. But appetite for hedge-fund products including separately managed accounts, private credit, co-investment stock funds and funds with longer lock-ups outstripped them both.

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Investors use separately managed accounts to obtain cheaper fees and more control in exchange for committing more money for more time. Co-investing is a way to put money into individual deals alongside a hedge fund rather than into the fund itself.

In another bright note for hedge funds, the survey found that more investors plan to redeem from passive long-only equities strategies, such as exchange-traded funds, than invest in them.

“Volatility has returned after years of benign, very calm markets,” Mr. Gasparro said. “At the same time, investors in hedge funds are finding a middle ground in terms of fees and terms. It feels a lot more constructive.”

Meanwhile, the fees charged by hedge funds keep falling, with use of the once-standard 2-and-20 model almost unheard of today. Just 3% of investors pay a 2% management fee, and 16% pay a 20% incentive fee. Instead, the average management fee is now 1.45% of assets, and the average performance fee is about 17%, according to the study.

The concessions hedge funds are making aren’t just about fees.

Credit Suisse found that over the last two years, about a quarter of allocators persuaded managers to cover expenses that were previously passed on to clients in addition to fees. The least-acceptable costs investors say they face include compensation for noninvestment professionals and travel.

The study was conducted from May to July and covered 279 participants, from pension funds to private banks, with $1.04 trillion in hedge funds.

— With assistance by Hema Parmar