Where have all the hedge funds gone? Advisors weigh in

John Dodd of Catalyst Private Wealth and Ford Donohue of Homrich Berg

Not too long ago financial advisors would bend over backwards to get their high-net-worth clients into exclusive hedge funds.

Does anybody remember hedge funds?

There was a time not too long ago when financial advisors would bend over backwards to get their high-net-worth clients into hedge funds. They would scout for the hottest managers – long/short, global macro, multiple varieties of arbitrage, etc. – and let their charges pay handsomely for the privilege of having Wall Street’s best and brightest manage their money, sometimes to the tune of 2% of assets annually, plus an incentive fee of 20% of profits above a set hurdle rate.

Nowadays, however, the silence surrounding hedge funds and their formerly big-swinging directors is almost audible. The asset class certainly still exists, with around $5 trillion in assets under management globally, but nobody seems to talk about hedge funds much anymore. That is, unless it’s a big activist player like Nelson Peltz agitating for management change at Disney or Bill Ackman doing the same at Harvard.

Seriously, where have you gone, David Einhorn? A nation of accredited investors turn their lonely eyes to the Sohn Conference for a tip on the next big financial firm that’s likely to fail.

“Hedge funds are dead as a doornail,” said Michael Sonnenfeldt, founder of ultra-high-net worth investing club Tiger 21. “Hedge funds have had a secular decline over the last decade because our members who wanted that exposure found that they could get it cheaper and better, less fees with the indexes or go direct with private equity.”

The Tiger 21 Asset Allocation Report for the third quarter of 2023 showed a decrease in allocations to public equity and hedge funds, with corresponding upticks in cash and fixed income. Public equity declined in allocation to 20%, down one percentage point from the previous quarter. Private equity was the largest piece of the pie at 30%, with real estate coming in at 25%.

Meanwhile, members of this moneyed club trimmed their third-quarter allocation to hedge funds by one percentage point to a mere 2%.

“The biggest increase has been in venture capital,” Sonnenfeldt said. “That’s where our members know long-term potential can create huge value.”

Daniel Lash, financial advisor at VLP Financial Advisors, says he does not recommend hedge funds for multiple reasons, including the substantial minimums and high fees. He’s also not a fan of the limited liquidity of some funds, which “can also be an issue with only having quarterly or annual redemptions with limits on the amount of redemptions.”

All that said, Lash still sees a role for hedge funds in a client portfolio, but only if those clients are really, really rich, having $10 million or more in investible assets.

Nina Lloyd, president of Opus Financial Advisors, part of Osaic, also avoids using hedge funds for her client base, citing many of the same reasons as Lash. She has another reservation as well: the lack of transparency and regulation for many funds.

“Hedge funds don’t provide the same transparency we demand from more traditional investments,” said Lloyd. “Within the last six months, a hedge fund was used in our hometown of Chapel Hill, N.C., to fraudulently steal more than $9 million from local investors in a Ponzi scheme. Significant due diligence is required by even the savviest investors.”

Robert Pearl, co-founder and wealth advisor at G&P Financial, is even more critical of the industry as a whole.

“Seems to me that the only people that make money in hedge funds long term are the people who own or work at the hedge fund,” he said. “Hedge funds and most alternatives have the illusion that they can beat the market and in addition to providing less volatility. I believe there is no such thing as a free lunch.”

Pearl suggests owning registered index-linked annuities such as Brighthouse Shield or Prudential FlexGuard for those advisors who want to add a buffer to a portfolio or reduce market volatility. He added that investors seeking a wide exposure to stocks should utilize ETFs if they want to keep costs low.

Speaking of ETFs, ETF.com notes that there are now more than 40 publicly traded, hedge-fund-style ETFs with total assets under management of nearly $6 billion and an average expense ratio of just under 1.2%. So there’s that option for advisors too.

For Cyrus Amini, financial advisor at Helium Advisors, it comes down to performance. As he sees it, that’s been lacking for hedge funds of late, especially compared to the most popular market indexes.

“While equity markets, especially the Nasdaq and S&P 500, are currently trading close to their all-time highs, this is a time where we want to maintain flexibility in our portfolios,” Amini said. “Many hedge funds have underperformed the broader indices over the past 1-, 3-, and 5-year time periods. For those hedge funds in the top decile versus their peers, most of them are closed as they don’t need new clients.”

THE CASE FOR HEDGE FUNDS

On the flip side, Ford Donohue, principal at Homrich Berg, does recommend an allocation to hedge funds for conservative and moderate risk clients, ranging from 5% to 8% of the overall portfolio.

“We have sought out hedge funds that potentially have the ability to produce an alpha-based return stream that is in excess of bonds that provide diversification from stocks and downside protection in times of market stress,” he said.

Donohue structures this allocation in a unique way to keep costs down, however, by serving as an advisor to an internally managed fund of hedge funds for his clients.

“We have found this structure to be an attractive way to gain ‘one-stop shop’ exposure to a diversified portfolio of hedge funds that would otherwise have very high minimums or an added layer of fees to access through a feeder fund,” he said. “This structure also allows for accredited investors to invest at relatively low minimums of $25,000 and without the tax complexity of a K-1 that is typical of many hedge fund investments.”

Likewise, John Dodd, chief investment officer at Catalyst Private Wealth, advocates that clients have reasonable exposure to diversifying strategies within a core portfolio. Within a balanced portfolio, for instance, he currently allocates 5% of invested assets to a multistrategy fund run by AQR.

“We believe that diversifying your diversifiers is wise,” Dodd said. “Many individual strategies can go through prolonged periods of challenging performance, combining multiple strategies together can lead to a less bumpy ride for investors. Such an implementation approach can help clients stick with an allocation.”

Finally, Dustin Thackeray, chief investment officer at Crewe Advisors, typically allocates 3% to 6% of a client’s portfolio to hedge funds depending on the client’s objectives and accreditation.

“We typically utilize concentrated fund-of-funds offerings that focus on multistrategy funds, or multistrategy funds as stand-alone,” Thackeray said. “We like the diversification benefits these types of funds offer to a diversified portfolio.”