In the aggregate, 2015 hedge fund gains were in the neighborhood of -2.01 percent. The Dow finished 2.2 percent in the red and the S&P 500 bowed out with a 0.07 percent loss. Meanwhile, the Fed signaled an “all’s well” with the economy, by raising the discount rate a quarter point in its December meeting. Despite this litany of lamentable facts, hedge funds raked in $45 billion in new money from investors and hedge funds managed $3 trillion in assets in 2015.

How Long Can This Go On?

That is the $64 thousand dollar question. Cash inflows to hedge funds in 2014 totaled $76 billion. As mentioned previously, 2015 inflows fell to $45 billion, a year-over-year decline of more than 40 percent. This fact, coupled with the spate of hedge funds converting to family offices and institutional redemptions, both public and private, gives rise to legitimate questions regarding the future of the industry.

Pension funds, endowments and high net worth individuals are the lifeblood of the hedge fund industry. Realistically, how long will these investors continue to rely on hedge funds to provide superior returns and mitigate losses in their portfolios? While there are a number of hedge funds that have accomplished these twin tasks…roughly one-half have not.

Returns Are Looking Up

Hedge Fund Research (HFR) reports the average hedge fund returned around 1.6 percent through the first half of 2016. However, S&P 500 gains were more than twice that figure, coming in at 3.84 percent for the same period.

Despite a challenging start, July marked the fifth consecutive month of hedge fund gains, which boosted the prior twelve month average returns to a positive number for the first time this year.

No Time for Complacency

While the statistics suggest a turnaround, one must not lose sight of the fact that S&P 500 gains were dramatically impacted by the United Kingdom’s ‘Leave Vote’, which triggered a sell-off in the stock market. This phenomenon was short-lived and the S&P 500, as a result, is boasting a year-to-date gain of 8.32 percent as of August 12th, 2016.

Meanwhile, more hedge funds have shuttered in recent quarters than have launched. For example, in the first quarter of 2016, the net number of hedge funds dropped by 85 firms. Although last year, hedge fund closures increased to a level not seen since the financial crisis, the net number of hedge fund firms actually expanded.

The contraction the industry is experiencing through the first half of 2016 is occurring on two fronts—1) assets under management, 2) actual number of hedge fund firms.

Finding the Silver Lining

Many will argue that these indicators spell doom for the hedge fund industry. Contrarians can reasonably argue that these developments are actually positive. Any business that fails to meet the needs and expectations of the consumer will ultimately fail.

With around one-half of all hedge funds in negative territory with respect to gains, it is no surprise to see many shuttered and/or redeemed out of existence. This is an expected result in a free market economy. It is not a condemnation of the hedge fund industry as a whole, but rather the manifestation of consumer will and a signal to the industry that investors demand a better result.

Hedge fund managers that meet investor expectations will flourish—those that do not will perish.

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