Despite its enduring mystique as the smartest corner of finance, the hedge fund industry has been shrinking in recent years as investors disappointed by underwhelming returns increasingly favor lower-cost alternatives for managing their money. This year’s Covid-fueled market volatility hasn’t redrawn that picture. Figures just in for November suggest that even when stock pickers do well, they still can’t beat the markets against which their performance is measured.

It’s not that it hasn’t been a good year. Hedge funds have just posted their best collective monthly performance for six years, delivering returns of almost 5.5%, according to data compiled by Bloomberg. But even the top-performing strategy available last month, with long-biased equity funds registering double-digit gains, still couldn’t match the returns available from benchmark equity indexes.

The longer-term picture is even bleaker. The average return for hedge funds this year is less than 6%, compared with more than 14% for the MSCI World Index and better than 16% from the S&P 500 Index.

Of course, there are some big winners in the hedge fund community. Balyasny Asset Management LP gained 30% in the first 11 months of the year, Bloomberg News reported last week, citing people with knowledge of the matter. And billionaires Chris Rokos and Alan Howard both delivered outsized gains as the coronavirus roiled markets earlier in the year.  

But some of the industry’s biggest names have struggled this year. Flagship funds at Renaissance Technologies LLC, founded by Jim Simons, and Ray Dalio’s Bridgewater Associates LP have declined by about a fifth this year. Others have suffered reversals: Said Haidar made more than 25% in March as the pandemic trashed global stock markets, only for his Jupiter macro hedge fund to lose 23.5% last month, my Bloomberg News colleague Nishant Kumar reported last week.

The challenge for investors in deciding whether to allocate capital to a hedge fund is the same as for any strategy involving active manager selection: It’s impossible to know in advance which fund will be a winner. Past performance is by no means a guarantee of future success.

So investors have been shunning the sector, withdrawing a net $42.4 billion between April and June for a ninth consecutive quarter of outflows, data collected by research firm eVestment show. The total amount managed by the industry has dropped below $3 trillion for the first time since 2014.

As a result, more firms have shuttered than started for eight consecutive quarters, according to figures compiled by Hedge Fund Research Inc. In the first half of this year, more than twice as many managers threw in the towel as opened for business, with 482 funds liquidating versus 213 new ventures.

Those brave enough to join the fray are finding a less lucrative business than in the past. Investors continue to drive down the fees they’re willing to pay for the dubious privilege of handing cash to hedge funds. The halcyon days of “Two-and-Twenty” — 2% of the total assets being absorbed as a levy, as well as 20% of any gains — are truly over for the industry as a whole. In the second quarter, the industry’s average management fee dropped to 1.37%, while incentive fees declined to 16.37%, both reaching record lows, according to HFR’s figures.

Cheerleaders for active managers have argued in recent years that one-way gains for stock markets neutered their ability to generate alpha. With the coronavirus creating more turbulent markets — this year’s average value of the VIX index of equity volatility this year has been double last year’s mean — 2020 should have been their time to shine. Given the ongoing lackluster performance, financial Darwinism should and will continue to thin the hedge fund herd.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mark Gilbert is a Bloomberg Opinion columnist covering asset management. He previously was the London bureau chief for Bloomberg News. He is also the author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.”

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