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A year ago, our Strategic Consulting team reported that momentum for hedge funds was building, setting the scene for a new era of opportunity. That was before a global pandemic triggered one of the most severe stock market selloffs in history.

Still, 2020 proved to be a strong year for hedge funds, which not only generated positive returns, but also the fourth-highest upside capture rate and alpha in two decades. Hedge fund assets under management reached an all-time high of $3.6 trillion in the fourth quarter, driven solely by performance, as the 1H20 outflows were not quite offset by the 2H20 inflows.

Results from the most recent Strategic Consulting investor survey show that 2021 could be a breakout year, with a projected $10 billion to $30 billion of net inflows and ~$450 billion in gross allocations across the industry.

$450bn expected gross allocations to hedge funds in 2021, of which $10-30bn is expected to be inflow

Source: HFR, Barclays Strategic Consulting Analysis

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Investor interest in hedge funds is the strongest in years

In the Strategic Consulting survey of 240 investors, who collectively represent more than 20% of the industry’s capital, every investor type indicated plans to increase allocations. Furthermore, investor sentiment toward hedge funds is the most favorable it’s been since 2014.

Among other factors, there is significant pent-up demand from investors. In aggregate, they pulled $30 billion from hedge funds in 2020, marking the third consecutive year of marginally negative flows for the industry.
Now, with significant cash sitting on the sidelines, all investor types indicated plans to put more capital to work. Hedge funds were second only to private equity/venture capital as the preferred asset class, with 41% of investors indicating they plan to increase their hedge fund exposure.

While all investor types plan to be net allocators to hedge funds in 2021, Family Offices and Private Banks indicated the most bullish plans for the year. The key drivers of allocations to hedge funds differ across investor types, but the main objectives, broadly speaking, are 1) diversification, 2) risk mitigation, and 3) potential to earn equity-like returns with bond-like risk.

Investors indicate plans to increase exposure to HFs in 2021
Chart of net allocations (%) investors indicate in our Strategic Consulting team's investor survey

Source: Barclays Strategic Consulting Analysis

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Hedge funds performed well in 2020, but only after a significant drawdown

In markets, 2020 could be summed up as a tale of two extremes — and hedge funds followed a similar pattern. The first quarter was exceptionally difficult for hedge funds, which saw larger drawdowns during the Covid-19 crisis than it did during prior corrections, both in terms of capture rate and alpha.

Those declines, however, were offset by significantly better performance when markets bounced back. The average hedge fund capture rate was 56% during the Covid-19 recovery, versus 42% for the past four crises. Alpha was 9.9% versus 2.1% for previous crises; only the Global Financial Crisis came close at 6.3%.

Moreover, following losses during the first quarter, hedge funds on average returned 26.2% for the best three-quarter performance since HFR began tracking hedge funds in 1991. All told, the industry's assets under management reached an all-time high of $3.6 trillion in the fourth quarter, driven solely by performance.

2020: A tale of two extremes for HF performance
Chart showing quarterly hedge fund performance versus past crises

Source: HFR, Barclays Strategic Consulting Analysis

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COVID-19 disrupted investors' allocation process, but they've adapted

Due to Covid-19, investors redeemed more than originally planned in 2020 as the pandemic made cash a premium for a number of investor types—hospitals and healthcare systems among them.

At the same time, the pandemic disrupted investors' allocation process. Because of the difficulty conducting operational due diligence under quarantine and social distancing, many investors opted to stick with existing hedge fund relationships last year rather than establish new ones.

With managers unable to meet face to face, 97% of investors adjusted their operational due diligence processes, and more than half plan to continue those changes post-pandemic. After generally not expanding their hedge fund rosters in 2020, investors appear likely to begin forging new hedge fund relationships again as they allocate an estimated gross of $450 billion throughout 2021.

To learn more about the outlook for the hedge fund industry in 2021, please ask your Barclays Investment Bank representative for the 2021 Global Hedge Fund Industry Outlook and Trends report, or contact the Strategic Consulting team at strategicconsulting@barclays.com.

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