Hedge Fund Expert Don Steinbrugge On Money Flows And Why Pension Funds Invest In Hedge Funds

Don Steinbrugge is one of the best-known experts in the hedge fund industry, with over three decades of experience in the field. He has been running Agecroft Partners, a global, award-winning hedge fund consulting and marketing firm for almost 10 years now.

Benzinga had the chance to chat with this seasoned hedge fund industry expert, who shared some predictions for trends in the space in 2017. In the first part of this article, we looked into hedge fund fees and how they’ll evolve over the year; in the second part, we went into the why hedge funds will benefit under the Donald Trump administration. In this third part, we’ll take a look at asset outflows and why pension funds invest in hedge funds.

Pension Funds

The expert first explained why pension funds invest in hedge funds. “[The objective of] most pension funds that are allocating [resources] to hedge funds is not to beat equities, their objective is really to beat fixed income. These pension funds need to be diversified; they can't have 100 percent in equities, because if the market sells off, at some point, they may not be able to pay pension benefits. So, if hedge funds can outperform their fixed income portfolio, provide uncorrelated returns (that don't move in the same direction as the bond or equity market) and also help the pension funds if the markets sell off, that adds value to the pension fund.”

“So, that's why they are investing. They are investing to beat bonds – and their bond portfolio right now is projected to generate somewhere around 2.5 or 3 percent,” he continued. “So, it's not a very high bar for hedge funds to meet in order to add value to these pension funds — last year, the average hedge fund was up about 5.6 percent and the Bloomberg Barclays US Aggregate Bond Index was only up about 2.5 percent.”

“Despite that, the assets coming out of pensions are going to be a lot less than most people think,” he added.

Money Flow

Among the trends Agecroft predicts for 2017, there’s “a lot of negative flows or money coming out of the marketplace from large institutional investors. They are getting a lot of pressure from local media, from politicians, and from union employees, to get rid of their hedge funds,” Steinbrugge explicated.

“And, there's a disconnect between most people's impression of hedge funds and why institutional investors are investing in hedge funds. One of those disconnects is relative to performance. A lot of people compare the return of hedge funds to the S&P 500 and the SPDR S&P 500 ETF Trust SPY, and the reality is that is not the benchmark investors use for their hedge fund portfolio.”

“Hedge funds are a fund structure, and within that fund structure there are a lot of different strategies that have no correlation to the S&P 500 [...] You have money market funds, bond funds— For equity funds, you probably should compare those to the S&P 500, but most strategies [among hedge funds] don't have a lot of equity exposure,” he went on.

“Now, even though I do think that net flows to the hedge fund industry are going to be negative, I think in 2017 hedge fund assets will reach an all-time high,” the expert declared. “The average estimate is like $3 trillion. Last year, about 2.5 percent of the industry assets left, but the average return across hedge funds was 5.6 percent, so the performance offset the net redemption, which caused assets to be at an all-time high. And, I think we are going to see the same thing in 2017: We are projecting 3 percent net redemption from the industry, but we are forecasting an average return of 5 percent. So, we are expecting industry assets to be up about 2 percent at the end of the year.”