Why the hedge fund industry should welcome the pain it's experiencing

Don Steinbrugge, a managing partner of the Richmond, Virginia-based Agecroft Partners, a marketing and consulting firm for the hedge fund industry, predicted in January there there would be an “all-time high” in hedge fund closures in 2016.

“I think there will be,” he tells Yahoo Finance, “The first quarter was not good for the hedge fund industry. You saw significant dispersion of returns between managers in similar strategies and whenever you have this huge dispersion of of return—and in some cases it was over 20% difference in performance of hedge funds within a certain strategy—underperformers are going to get redeemed and go out of business.”

This, however, creates opportunities for the funds that are doing well.

During a volatile first quarter, investors pulled $15.1 billion in capital from hedge funds, making it the largest quarterly outflow since the second quarter of 2009, according to a recent report from Hedge Fund Research.

That’s a relatively small amount considering the hedge fund industry manages a little less than $3 trillion in assets. It’s a “very small percentage” that left the industry, Steinbrugge notes. He also doesn’t think it’s going to leave the industry entirely.

“Most of it’s going to either recirculate to those managers who did well or it’s going to shift between strategies,” he says. “I think what you’re going to see is money move from beta-oriented strategies to strategies that are not correlated with the capital markets.”

Another issues that’s been brought up lately is the incredible number of hedge funds in the space. Steve Cohen, who runs $11 billion family office Point72 Asset Management (formerly SAC Capital), recently said there are “too many players.”

“I think there are [too many],” Steinbrugge says, “I think 85 to 90% of fund managers are not worth the fees they’re paid,” he says, adding “I think there are 10 to 15% out there that are really talented.”

Steinbrugge thinks there are a number of strategies you can’t replicate with indices or ETFs and that it’s the job of sophisticated investors to identify those managers who have the ability to generate superior alpha.

Even though there’s been a great deal of criticism directed toward hedge funds by both investors and managers, Steinbrugge says the industry isn’t going anywhere. It may contract a bit, but the over all amount of money leaving will be relatively small.

“I just don’t see a lot of pension funds pulling out because there aren’t great alternatives for them to allocate their capital.”

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Julia La Roche is a finance reporter at Yahoo Finance.

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