What's in store for the hedge fund industry in 2021?

By Tom Kehoe, Global Head of Research and Communications, AIMA

Published: 14 December 2020

In the face of unprecedented global disruption arising from the Coronavirus pandemic, assets under management for the hedge fund industry continue to break new records.  The coming year is likely to see an acceleration of trends as the industry becomes more digitalised, more socially conscious and plays an integral part in the COVID-19 economic recovery. Below are the key trends that we see impacting the hedge fund industry over the course of 2021. This piece was also covered by HedgeWeek here and CitiWireselector here.

1. Hedge funds to witness a renaissance as investors reinforce their interest.

The environment and implications from COVID-19 demonstrated that in times of market volatility and business uncertainty – alternative investments fulfil an increasingly important role in an investor’s portfolio.  As has been the case where markets have sharply corrected, hedge funds continue to demonstrate their ability to minimise risk and deliver performance better than any other asset class. During the peak COVID-19 market volatility in the first half of 2020, hedge funds, on average, halved the losses incurred by equity markets and balanced portfolios.

This performance has not gone unnoticed with investors, with the consensus highlighting that allocations to the alternative portfolio has either met or exceeded their expectations. This sentiment has been loudly echoed through the course of our conversations with asset allocators who are reinforcing their interest in alternative investment funds; investing in both public and private markets as they seek diversification away from low interest bond and high valued equities. A major rethink on portfolio allocation will see alternative investments play a greater role in investor preference, with hedge fund investing becoming more prominent. We are in the middle of an evolution where hedge funds that innovate and are flexible will become asset managers that succeed and grow.

AIMA will publish its 2021 investor survey in conjunction with Pageant Media on Wednesday January 6th

2. New blueprint for hedge fund operating model to emerge.

Having most of the world be forced to work from home reshaped how businesses conducted their operations during this year.  More than most, hedge funds proved themselves to be highly adaptable and resilient in the face of a massive disruption. Their operations and their ecosystems not only continued in an unprecedented decentralised setting, but worked almost seamlessly with little or no interruption. 

The pandemic has brought about significant changes in the way hedge funds operate. With the end of the pandemic now in sight, business operating models are being re-evaluated as hedge funds examine core processes, cost structures and hybrid working environments as they drive for efficiency in a new normal.  

To read more about how hedge funds are operating in this new environment and transitioning to a new normal, please see Agile and Resilient

3. Culture to dominate the talent management revolution:  

While COVID-19 has seen job losses across the financial services industry, hedge fund managers continue to seek out the best talent while remaining mindful to also look after their own people.   Success in being able to work remotely has prompted many managers to consider hiring key investment professionals from outside of their typical vicinity.

Among the leading findings from the Agile and Resilient paper is that the impact of remote working and its effects on employee wellbeing has seen culture and collaboration become an increased priority.

Defining a clear strategy as the industry considers the future of the workplace over the coming years will be critical. Related to a firm’s culture, talent flight is now the number one risk to a firm’s long term growth. Senior management recognise that losing key employees or failing to attract specialised talent can have a detrimental impact on future business performance.

Note – AIMA will be holding a series of manager roundtables discussing how firms are managing culture in the new year.

4. Digital transformation of the industry to continue apace.

Remote working and forced lockdowns accelerated the digitalisation trend as COVID-19 reinforced the importance of having a strong technology backbone and infrastructure. Across the hedge fund industry, firms are investing to improve their businesses digital infrastructure and ICT capabilities.

Many firms are concerned about the challenges they will face securing their ICT perimeter and digital operational resilience as employees work from a variety of locations over the coming 12 months.  Significant focus is being placed on the need for enhanced cyber security, particularly where firms continue to be in a decentralised environment or move to a more hybrid working structure.

Arising from the pandemic, many industries have started to include the use of alternative data as a key part of their business-decision making processes.  We see a lot of opportunity for technology innovation to make insights from alternative data and seamlessly integrate it into the investment process. The immediacy of these data sets in comparison to the information lag from using traditional forms of data is proving particularly useful during this time.

Being pioneers of this area, the coming 12 months will see the hedge fund industry continue to move towards a more quantitative outlook with more firms looking to invest in alternative data and next generation tools like machine learning and blockchain technology.  

Elsewhere, the ecosystem for cryptocurrencies and digital assets is continuing to develop. The past year has seen more hedge funds emerge with an increasing number of investors examining opportunities in blockchain and the distributed ledger technology (DLT) space.  While this emerging alternative asset class is still relatively small, many analysts expect it to grow and yield more influence over the coming years.

Note – AIMA will be exploring how hedge funds are investing in cryptocurrencies and digital assets in research to be published next year.

5. ESG and Responsible Investment to gain in importance.

Amidst environmental issues and social justice movements continuing to dominate the news, 2021 will see efforts ramped up to integrate ESG and responsible investment (RI) across investment products universally. 

In terms of attitudes towards ESG presently, a lot of the impetus is still contractual with investors primarily driving the push for ESG and RI. This will change significantly next year with the onset of regulation, with the EU Sustainable Finance Disclosures Regime (SFDR) coming into force in March.

Sustainable finance is here to stay. At AIMA, we strongly believe that alternative asset brings unique skills to the world of responsible investment given their flexibility and sophistication. While the industry is already working hard to deliver sustainable strategies to investors that seek them, regulation must not stymie this. We will be working hard to ensure that well-meaning rules do not end up hindering the ability of managers to innovate and deliver for investors.

For all the latest industry insight, regulatory and practical guidance from AIMA on ESG and RI, please go here

6. Private Credit to play an integral part in COVID-19 economic recovery

The value of private credit to investors and borrowers has been subject to a rigorous examination during 2020.  The pandemic has challenged the viability of many businesses and the jobs they provide. Governments around the world have provided unprecedented liquidity support yet many borrowers found themselves unable to access such schemes.  Private credit managers have helped fill this finance gap and are expected to provide more than $100 billion of new capital during 2020 and plan to be just as active in 2021 as this credit cycle will continue to create opportunities.

Investors have also faced twin challenges of increased volatility across their equity portfolios and reduced fixed income yields.  Private credit has provided such investors with assets offering diversification, a hedge, and a new source of income generation.  By deploying new capital and protecting value in their existing portfolios, private credit managers have also demonstrated that the sector can perform through a downturn.

At the same time, the pandemic has also highlighted differences in deal origination, documentation standards and risk management capabilities between private credit managers.  This is likely to be reflected in dispersion of performance across the sector.

Institutional investors have been increasing their allocation to private credit strategies markets for some time.  This momentum is likely to be maintained in 2021 with private credit managers continuing to raise capital and provide much needed finance to businesses in need of capital.

Note - To read more about the role that private credit will play in the COVID-19 economic recovery, please see ACC’s Financing the Economy 2020 here.

7. Continued movement away from manager led products to investor tailored solutions

The alignment of interests between managers and investors continues to strengthen. The appeal for customised arrangements, like separately managed accounts and funds of one grew further over the past year given the greater control and transparency which these structures offer.

New partnerships are also emerging with co-investment arrangements becoming more popular in use across both public and private markets while Special Purpose Acquisition Companies (SPACs) are also being increasingly taken up by hedge funds.

This change reflects a growing trend within the hedge fund industry as it moves away from the product-led environment of the past to a marketplace increasingly populated by more bespoke investor solutions and value advisory services.