It’s tough out there for new hedge fund managers trying to raise cash, and it doesn’t look like it’ll get easier anytime soon.
That’s a key finding from a Goldman Sachs Group Inc. report Friday on the outlook for the industry, titled "The Waiting Game."
Investor appetite for almost every hedge fund strategy this year has diminished from 2023, which was already the weakest year on record for “money in motion” — Goldman’s term for gross inflows.
Interest in hedge funds is lower now than in the past two years, and on a dollar basis, more clients pulled money last year than made new bets.
They yanked $280 billion while putting just $75 billion into new vehicles in which they didn’t previously have investments, according to the report, which was based on a survey of more than 650 hedge fund allocators and managers by Goldman’s capital introduction team.
That contributed to a challenging fundraising environment. Managers were forced to scrum for limited cash as investors grew increasingly concerned about higher interest rates. Private equity firms struggled to exit deals and return cash to investors, making it more difficult for clients to deploy capital elsewhere.
When investors did back new funds, they did so tentatively.
“We can infer from our data that the average size of new investments was relatively small, implying that allocators may have chosen to put in ‘toe-hold’ positions when investing with managers new to their portfolios,” Goldman said in the report.
Rather than taking a chance on a new fund, clients preferred the tried-and-true, topping-up bets on existing managers. Last year, investors added $145 billion to funds in which they already had stakes.
There’s another dynamic limiting how much cash is up for grabs: investors choosing to stick with underperforming funds for fear of leaving just before they recoup losses.
Many stock pickers, despite gains last year, are still trying to make investors whole after losing cash in 2022. Two-thirds of equity funds remained below their so-called high-water marks as of 2022 — and of those, only 15% had eclipsed their marks as of the end of December. Those still in the red will have to gain an additional 18% on average to recover lost capital.
“Allocators may look to avoid crystallizing losses in existing managers to switch investments to new funds, which would effectively reset their HWM at zero for that investment,” Goldman wrote. “This continues to be an important dynamic in the hedge fund industry as, for investors, it creates a bias to the status quo.”
Goldman said it believes that this is a contributing factor to the weakness in new allocations.
The report also found that investor interest in multistrategy hedge funds is waning after reaching a peak in 2023, with 16% of those surveyed saying they plan to allocate to the strategy versus 31% going into last year. Meanwhile, 7% of clients said they plan to redeem this year, up from 4% in 2023.
“We believe that strong multiyear flows into the strategy, combined with somewhat softer performance last year, are driving this fall in interest,” Goldman wrote.
Credit is the most sought-after strategy for 2024. Even though it was the most desired going into last year, actual allocations ended up being muted in 2023, the report found.