Family Wealth Report explored whether family offices are pulling out of hedge funds, and, if so, why.

Concerns about high fees, underperformance and transparency have put pressure on the hedge fund industry in recent years, and indeed they are the “problem du jour,” according to KC Connors, head of NEPC’s private wealth team.

Nearly a quarter (24 per cent) of the foundations and endowments recently polled by the firm said they have no exposure to hedge funds, up significantly from 2 per cent in the Q2 2014 NEPC Endowment and Foundation Poll. Adding to this, 39 per cent in the Q2 2014 poll had 11-20 per cent of their portfolio allocated to hedge funds, compared to just 23 per cent in the latest survey.

As highlighted by Cathy Konicki, a partner and head of NEPC’s endowment and foundation practice group, the results do not indicate a mass exodus from hedge funds, but they do point to greater pressure being felt by the industry as a whole. According to data from Preqin sent to this publication, the number of active family offices in hedge funds has actually risen from 188 in 2012 to 454 in 2016, with average allocations having increased from 19.6 per cent to 23.2 per cent.

Overall, however, hedge fund appetite among family offices is mixed, Connors told Family Wealth Report. “Receptivity has a lot to do with how comfortable family members feel in the financial markets, which can have everything to do with both how family wealth was generated, but also subsequent investment interest,” she said. “A lot of people, particularly in the US, are seeing negative press on hedge funds, with large public investors stepping back. We consider that to be a good thing because as capital leaves it creates inefficiencies and opportunities.”

Meanwhile, in Preqin’s 2016 Global Hedge Fund report, Amy Bensted said that although some notable investors (such as CalPERS) have eliminated hedge funds from their portfolios in recent years, most institutional investors look set to remain active in hedge funds in the long term. Managers have also reported that sources of private wealth are once again increasing their allocations to their funds, Bensted added.

However, low returns and high fees have seen some family offices reconsider their allocations to hedge funds, said April Rudin, chief executive at the Rudin Group, and chair of the high net worth advisory board of the Hedge Fund Association.

“Opacity is an issue with a more enlightened investor who wants to understand more about an asset class or vehicle.  This is what I call ‘Millennially-minded,’” Rudin said. She added that family offices are gravitating toward private equity investments where they can form relationships with other families in “club deals,” and share expertise toward a common goal.

Connors also noted that the type of hedge fund strategies adopted by family offices depends on how they perceive the role of the hedge fund in their portfolio. For example, those that view their allocations as more of a portfolio equalizer or stabilizer are leaning toward private debt strategies, which tend to have a faster ROI turnaround and shorter illiquid restrictions. If they see the allocation as their “alpha engine,” on the other hand, Connors said popular strategies vary widely from public to private markets.

“I think a big reason why those that are most reticent to investing in hedge funds are hesitating or stepping back is because, originally, hedge funds were sold as the ‘big return enhancer,’ as opposed to generating stable returns with lower volatility,” she said. She added that the investment landscape generally has shifted over the last few years; it is less about broad beta market exposure and has become much more critical to find small, niche strategies that might have limited capacity, she said.