Having endured a difficult decade with regards to performance, 2018 proved to be a familiar tale for the hedge fund sector. After 10 years of bull markets and low interest rates, it has become apparent that the current market environment (and crucially the lack of dispersion) has hampered hedge fund’s abilities to generate returns. A recent study by Hedge Fund Research into the performance of the sector over the past year found that the average hedge fund lost around 6.7% over 2018.

While this was not the only sector to produce negative returns last year, this follows a decade of poor performance, a contrast with the 1980’s and 1990’s which were seen as something of a golden era for the industry. However, with financial markets entering a period of change, could now be the time for investors to increase their exposure towards the asset class? And if so, what do hedge funds need to do in order to generate greater investor interest?

A recent Preqin study, “Alternatives in 2019”, found that 79% of institutional investors surveyed plan to either maintain or increase their hedge fund allocations over the next twelve months. This is perhaps a surprising statistic given the sector’s performance in the recent past, but what is more notable is the way in which investors are looking to use these allocations to hedge funds within their portfolios: as a defensive tool. With many industry commentators suggesting that we have now reached the top of the bull market and with a market correction seemingly on the horizon, investor sentiment seems to be moving away from traditional asset classes, namely equities, and towards alternatives in a search for security. There is now a real demand for decorrelation and downside protection, and for many, this is just what hedge funds can offer.

Matthews Vincent from the Financial Times echoes this sentiment in his recent article, “Do alternatives deserve a place in your portfolio?”, in which he outlines how hedge funds, alongside commodities and asset-backed lending, can protect portfolios from what he refers to as “the great Powell U-turn” which has been a catalyst for increased volatility within global equity markets. This approach vastly differs with how the sector has been perceived in the recent past:  an alpha-driver within a portfolio, but a potentially risky asset class. But now it appears that a good proportion of investor appetite is now for the defensive aspect that hedge funds can offer, as opposed to the absolute return qualities that have previously driven interest.

However, challenges do remain, and public perception is certainly one. Hedge funds have developed a reputation for secrecy and a lack of transparency over recent decades, and this stereotype could prove to be one of the main barriers to attracting business, with it now becoming an industry norm for managers to not only explain what their funds are doing, but also how they’re doing it. With this in mind, it is now vital for firms to be taking a more positive approach to both their communications, be this with clients and intermediaries, internally or via media engagement.

There is a need for further education of the subject, but there remains a fantastic opportunity for the sector within the current investment environment. The most successful firms will be the ones that can shake off the stereotypes of past and clearly outline the just how versatile hedge funds can be within a modern investment portfolio, at a time when the demand and need for de-correlation and downside protection are greater than ever.