Rich private investors are turning their backs on hedge funds because moves to attract more conservative pension fund clients mean managers no longer deliver the big returns they crave.
The fastest growing source of new money for hedge funds is now pension funds and insurance companies who want managers to go easy on risky trades.
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Funds are finding it hard to say no to the big money these investors offer so rich clients are feeling neglected.
The hedge fund industry's changing investor base has also corresponded with explosive growth in size, leaving rich clients questioning how easy it will be for managers to make money in future. Global assets in hedge funds now top $2 trillion, far more than the $200 billion or so run in the mid-1990s.
"That's a huge deal," said John Elmes, Head of Investments at GenSpring Family Offices, which runs money for some of America's most prominent families and has invested in hedge funds since the late 80s. "It makes it very hard for these managers to continue to outperform."
Hedge funds seek to exploit and profit from inefficiencies in markets, and unlike traditional investment funds which only bet on prices rising, they have the mandate to wager on prices falling and can borrow money to amplify the size of their bets.
But with much more capital chasing the same opportunities those inefficiencies are quickly ironed out, making it harder for managers to earn returns above the market.
So instead of hedge funds, many of the private investors are putting their millions into private equity, old-fashioned long-only stock pickers or even property or fine wine, which have often outperformed hedge funds since the 2008 financial crisis.
The new breed of investor - such as the Church of England and the UK's Universities Superannuation Scheme - choose hedge funds for very different reasons than did the friends, family and few favoured high-rollers who originally backed managers.
While many want funds to mitigate against falls in their other investments - one of the original purposes of hedge funds - they do not want them to do this by simultaneously taking on big risks looking for huge potential profits.
This means funds are forced to curb some of their more aggressive tactics, such as using lots of borrowed money to amplify the scale of trades - a far cry from the golden age of hedge fund returns before the crisis, when the nascent industry built a reputation for high-risk and audacious trading.
Vintage years like 1999, when the average fund made 31 percent, contrast with more subdued performance recently.
According to Hedge Fund Research, the annualised return of the average fund over the past 10 years is 6.77 percent, but drops to just 1.44 percent for the past five.
George Soros forged his reputation as a savvy trader betting against the British pound in 1992; John Paulson turned himself into a billionaire betting on a U.S. housing market slump.
There has been no equivalent high-profile success story of canny trades harnessing the euro zone debt crisis. Many institutions would not want managers taking the risks such gambles incur.
"High net worth investors went into hedge funds in many cases because they personally knew the manager, they wanted significant returns and weren't hugely concerned with monthly numbers or volatility," Anita Nemes, Global Head of Capital Introduction at Deutsche Bank, said.
"Institutional investors want uncorrelated returns and low volatility from hedge funds. (They) want different things."
According to Deutsche Bank's Alternative Investment Survey, family offices and high net worth investors now account for just 4 percent of industry assets, down from 18 percent in 2002.
While private banks' share has grown, to 10 percent from 6 percent, investment consultants, who advise institutions on hedge fund investing, have seen their share rocket to a quarter of industry capital, up from only 1 percent a decade ago.
GenSpring's Elmes said his clients, who on average are worth more than $30 million, have reduced their exposure to hedge funds by 20 to 25 percent on average since the financial crisis.
Heartwood, a London-based wealth boutique managing more than 1.4 billion pounds, constructs portfolios based on clients' tolerance for risk. Investment director David Absolon says its highest risk portfolio no longer invests in hedge funds.
Even those who have traditionally run lots of money for private investors - such as Odey Asset Management or Egerton Capital - now count more and more institutions among their clients.
One London-based hedge fund manager, who asked not to be named, said since 2010 high net worth clients had withdrawn money from his fund, particularly those based in continental Europe.
NO EASY MEETINGS
The average hedge fund is up 3.9 percent over the past three years, underperforming the S&P 500, which is up some 30 percent.
"When you see funds doing 2 percent a year for one, two, three years in a row, it becomes a little bit hard to digest that you must have hedge funds in your portfolio," Francis X. Frecentese, Global Head of Hedge Fund Investments at Citi Private Bank, told Reuters.
On top of the question marks about returns, as funds grow larger, the personal relationships wealthy investors held with top traders grow harder to maintain.
A senior executive at one London-based family office, asking not to be named, sold his stake in a large global macro manager because he struggled to get a meeting with the chief trader.
"Pre-08, if your investor base was mainly high net worth all you had to do was publish a monthly investor letter and have regular meetings. Now most hedge funds have large marketing and client service teams - huge numbers of people - that service pension funds clients," Nemes at Deutsche Bank said.