The evolution of hedge fund performance: From enhancer to diversifier 

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John Schlegel: Welcome to J.P. Morgan's Making Sense. I'm John Schlegel, head of the Global Data Assets and Alpha Group within Prime Financial Services. Today, I'm joined by Kumar Panja, who is the Head of the Capital Advisory Group for the EMEA region. Kumar, it's great to be sitting down with you as I'm in London this week.

Kumar Panja: I'm glad that you're here. Glad we can make this work, John.

John Schlegel: It's great being with you because there's a lot I think we can really discuss between the two of us around what we're seeing in the hedge fund space. But first, I'd just like to note that we're recording this in early October. And while much of our focus will be less on the immediate past or future, if there are some big surprises this month, some of this conversation could be a little bit different. Before we get to the focus of this episode, Kumar, do you mind giving us a brief overview of your role?

Kumar Panja: Sure. So the Capital Advisory Group is a value-added hedge fund client-focused function that sits in the sales and marketing division of the investment bank. We work very closely with our prime financial services business. One of our lines of business is capital introduction, which as the name suggests, introduces our hedge fund clients to institutional investors who allocate to hedge funds as part of a wider portfolio. That would include investors ranging from sovereign wealth funds to pension funds, endowments and foundations, private banks, family offices, among others. I run the group for the EMEA region and is run globally by my colleague, Mike Monforth.

John Schlegel: Thanks, Kumar. For those who aren't familiar with my role as head of this Data Assets and Alpha Group, I generally focus on things covering tactical market takes as well as focus on data that we can deliver to our clients. But really for the purposes of this podcast, I'll be focusing mostly on what we call positioning intelligence, which centers around what we see in the hedge fund community amongst other allocators and how that affects the markets. So it's really interesting to have this discussion as the year has been quite the whirlwind of events, whether it was the Iran conflict that started off in March or the AI momentum rally that really affected a lot of funds in the second quarter, as well as the unwind we saw post that in the third quarter. So a ton to potentially discuss, but maybe starting off with what we're seeing on the performance side, given the volatility, what do you see in the high level data?

Kumar Panja: Sure. If we look at performance year to date, it's very clear that equity remains the clear winner. Equity long short and long only are for us, at least from our data, the standout strategies, while relative value macro and credit have lagged the broader hedge fund universe. And I stress by saying these are averages, there's a dispersion in individual manager performance. And the biggest story is for us is dispersion, not just returns, because within equity long short, managers at the 75th percentile have generated over 12%, while those at the 25th percentile are barely positive at 0.5%. So even in the best performing strategy outcomes do vary dramatically, highlighting the importance of manager selection. Long only has been more consistently successful. Despite a similar average return to equity long short, the median long only manager is up 12%, significantly higher than the 5.65% median number we have for equity long short.

John Schlegel: That's really interesting. And I think it does jive a lot with what we've seen and heard. One thing that we track based on the positions clients hold with us is what we see for their equity performance of the book. So we can't necessarily see everything, but the overall story has been one of very strong performance in equities, particularly in the second quarter, which drove a ton of the gains. When you think about what drove that, a lot of that was related to AI in some way, shape, or form. But what's also been interesting is a strategy that has been very much in focus over the last few years, namely the quants, typically had a bit of a rougher time in the second quarter with some of the volatility that was going on. And they, from our data, seem to be the ones really holding up very well in the last few months. So the third quarter, I would say, very strong for a lot of the quantitative managers and a lot more mixed for more of the fundamental funds. But I think another element of what we're seeing recently is the focus regionally. So by this, I mean, when we look at alpha year to date, and arguably even the last couple of years, it seems like a lot of this is coming from Asia. Is that something that you're also seeing and feeling?

Kumar Panja: Well, we've definitely seen an increase in global investor interest in Asia Pacific, as well as greater China. And that is partly performance chasing, but it's also a reflection of the fact that Asia has been perhaps an underweight in those portfolios. So those two factors have come together quite happily, which has definitely generated a lot more interest. And my colleague, Stephen Kelly, and his and James Tan in Asia, who cover the capital team there, have been very, very busy in terms of global investors that want to learn more about APAC specialist managers.

John Schlegel: Can you give us a sense as to how the returns compare regionally, maybe in the equity space?

Kumar Panja: Sure. And as we said before, I think the overarching theme is that geography mattered as much as strategy selection. And in several cases, the gap between the same strategy in different regions was larger than the gap between entirely different strategies. And so if we pick on equity long short, that saw, again, according to our data, the most dramatic regional divergence in the data set. APAC managers delivered an exceptional average return of 22% compared with just 4% in EMEA and 9% in the Americas.

John Schlegel: When you compare it to market indices year to date, that gap in performance is actually wider than what you see for the broader market. So if you know, if you look at different ways of measuring alpha, the alpha generation in Asia has been far superior to what we've seen in other regions year to date. So I guess moving on from what the facts of the returns are and have been, when you talk to allocators, are they generally happy with the returns? Are they starting to chase it a bit more? It does seem like hedge funds have become popular again. What's your take on this?

Kumar Panja: The team is full employment in terms of incoming from investors. And so I think hedge funds have definitely been going through a resurgence, probably fit to be fair for the last sort of 24 months. But as you say, the $64 million dollar question is, you know, what do those investors feel about the go forward? And interestingly, I was with three very large institutional investors just yesterday, and we discussed the same question. And their answer is their hedge fund books overall, and that's across all strategies, have done very well this year, despite some of the drawdowns that we've talked about during this year. Now, one needs to keep in mind that institutional investors typically look at investments, even in public market hedge funds, over a multi-year period. They don't like admitting that to their hedge fund managers they invest in, but they do tend to look at these investments over a multi-year period. So the fact there's been one or two months of dislocation doesn't necessarily change their allocation strategy. What it might do is, as you would expect, it delays the deployment of capital to take advantage for them of a lower watermark or a lower net asset value NAV entry point into that manager. But feedback overall from our wider investor base would suggest that we'll see continued inflows into the hedge fund space.

John Schlegel: So investors being thoughtful about, not trying to necessarily, perhaps, chase the returns. I think it's interesting that they're looking for better entry points, which historically, I would have argued maybe 15 years ago or so, it was more about chasing whoever's doing really well. Related to that, as clients or investors are looking at hedge funds in their portfolio, is it more about diversifying returns or enhancing returns?

Kumar Panja: And it's a really good question, John. And I think you've hit the nail on the head in terms of what institutional investors now expect from that hedge fund portfolio. So traditionally, a hedge fund portfolio was very much built to be, in some cases, a return enhancer. And that was many, many years ago. Nowadays, they're built to be a diversifier. But some of the issues that investors raise today is, the level of leverage that some managers are running. And then when they take that together with crowding or concentration, there is a sentiment, and it is a sentiment, it's not backed up with flows yet, a sentiment that hedge funds may well provide less diversification than originally planned in that portfolio. Going back to hedge funds as a protector, if you mean specifically tail hedging strategies, there are some hedge fund strategies managers that specialize in this space. And whilst portfolio theory tells us that it's a useful tool to have, tail hedging strategies have been very expensive in terms of capital bleed and capital erosion over the last few years. And as I caveat that by saying, there have been and continue to be some notable exceptions. So fewer investors use hedge funds as a protector, but they do use diversification as the main benefit.

John Schlegel: That makes a lot of sense. I think one of the interesting things that you just brought up in terms of, will they be as much of a protector? There is kind of an open question of, if they're growing so much, do they become the market? Often this is one of the arguments against some of the large companies and the concentration risks in the U.S. equity market is, at what point do the companies be so large that they can't really grow and outperform the wider market because they are the market, right? I don't think we're there yet on the hedge fund side. When you look at something like a measure of leverage in the hedge fund universe, this has certainly been a focus by many different folks within the industry, outside of the industry, regulators, et cetera. And there is potential cause for concern that sometimes comes up. Leverage levels and the amount of borrowing is objectively higher and has been trending higher over time. But I think what that oftentimes misses is the wider context. And by this, I mean, if you think about how much the market has grown, it's grown significantly in the last 5, 10 years, whether it's the performance of a lot of markets or the overall market cap or the turnover. I mean, one of the things in the equity market that's happened is you have this influx of retail investors. And so the thing is, when you have higher asset levels and more turnover, well, if you are a hedge fund that likes to make long and short bets and trade around things, there's more to do, right? And so we're only seeing the total assets on a levered basis kind of keep up in line with those market metrics rather than exceed them. I think it's one of these things where as long as the markets hold up, really, there's not necessarily this big disconnect where we've overshot in terms of the hedge fund leverage. So that'll be something to watch, though, over the next few years and could depend on do we continue to see this AI-led growth in wider market performance and economic growth continue, or is it something that really causes that to slow down or reverse? So maybe to shift gears again a little bit, Kumar, I know that you had recently done a very large investor survey. What are the areas in particular that you see allocators looking to deploy more capital into?

Kumar Panja: Thanks, John. so just to back up, so the investor sentiment, which we talked about earlier, continues to be positive. And just to give you a stat from that survey, 98% of investors expect to maintain or increase their hedge fund exposure. Now, interestingly, 53% of incremental hedge fund exposure is coming from new capital deployed. So some of it's compound growth, of course, but there is new money flowing in, which is obviously the big barometer of whether-

John Schlegel: That's good to hear.

Kumar Panja: Yeah, whether those investors are voting that hedge funds continue to grow in their portfolios. Now, your question earlier was around strategies of interest, what's interesting. It is actually quite diverse, but it's skewed towards larger managers. So another statistic from that survey, that's quite interesting is 86% of the $90 billion of flows in the first half of 2026 this year have gone to managers with greater than $5 billion of AUM. So clearly, there's a preference towards the larger managers. In terms of particular strategies, it's macro specialist equity long, short. And as you mentioned, quant, quant's done very well, statistical arbitrage, high-frequency quant have been most in demand. If we then put a regional lens on it, then as we discussed earlier, APAC regionally has been most in demand.

John Schlegel: That's really interesting. I mean, on the strategy side, would you say a lot of this is kind of a reflection of this desire for diversification?

Kumar Panja: It is. What is healthy to see is that specialist equity long, short has come back in because there's a long period where specialist equity long, short was not performing, So while quant has always been popular, it's grown in the understanding of how systematic strategy and quant can fit into a wider portfolio. So there's a growing number of investors who will include quant in that portfolio. And as we said before, multi-strats have proven that they can provide that high single, low double digit, uncorrelated return through the cycle. And that's been very attractive to investors, particularly going into a period where there are worries perhaps around levels of leverage and they need managers to kind of perform. There's also a question of scale as well. These large multi-strats can take the type of capital that these investors want to deploy.

John Schlegel: Yes. Now supply and demand, they're very much at work. And when there's certainly a decent amount of demand to write large checks, you need the supply to provide that in a thoughtful way.

Kumar Panja: The other interesting thing I'll mention, is investor innovation. And by that, I mean enhancing returns through leverage and customization. And that's steadily growing. So of course, hedge funds have been doing it for a while, but we've seen institutional investors utilizing tools. So again, another stat here to say 18% of investors surveyed leveraged their hedge fund portfolio. And 14% of investors surveyed use things like custom baskets to manage their exposure. So they are now mature enough to say, well, we'll let managers run their strategies. There may well be correlations. We'll dampen that at the overall portfolio level, something they didn't used to do. And I think there's been an increase in sophistication at the institutional investor level together with a flourish of products that banks like ourselves provide to those investors.

John Schlegel: More transparency on their front and ability to monitor things so they can actually take action and be more front footed.

Kumar Panja: Exactly. So John, what are your views on where you think that the markets go from here? And particularly, the question I know that you've been asked by our investors have been, what's the impact then on particular hedge fund strategies?

John Schlegel: Yeah, so I think the house view from J.P. Morgan is still, I would say, fairly constructive. So equities generally we think will go higher into year end. Bond yields may come off a little bit from the recent highs that we're seeing, but still could remain a bit more elevated. And I think what that means is for a lot of the strategies, what we're seeing is there is still exposure to the AI theme. People still are bullish on it, and that is expected to be the continued driver for the time being of the market. And so I think in general, as long as that theme continues, that should be helpful and additive to clients' portfolios. That being said, we don't think clients are overly exposed on a directional basis to the wider market. I think there is the obvious risk then, if for whatever reason, the AI theme were to reverse very significantly, that would be pretty challenging for a lot of funds. But once again, it's not because funds are taking outsized, market bets overall, but more so that they still have a preference for this theme. I think on the broader macro side, it's a little bit less clear. We think funds have been leaning more short bonds in the hedge fund space. So some, especially on the systematic side, have been making a decent amount of money, as the trends have been what they are with yields trending higher. You know I guess the thing could be, if you get the surprise of yields much lower, bonds rally really hard, especially if that were because of a more negative scenario. Usually yields can fall if there's fears of recession or downturn, right? That would generally be a very negative thing. But just to give you a stat, when we look at U.S. equity markets since 1950, whenever the S&P has been up over 10% through the end of September, only in five out of the last 30 years that that's happened has the market been down. And only one year it's been down more than 1% in the fourth quarter. So statistically, the likelihood that the market sells off very sharply in the fourth quarter is very low. I think one of the interesting things is we actually see, in the equity space at least, clients delivering more alpha when the markets are down than when they're up. And so if that pattern, persists, then even if we do get a bit of a downturn, a lot of hedge funds have been historically able to take advantage of that. Maybe on a net basis, if they're running that long, they don't actually make positive money, but they tend to protect capital decently well.

Kumar Panja: Good. Thanks, John. And I think that also aligns with our view from investors that hedge funds, for them in their portfolios, have done what they were supposed to do so far this year. And you've outlined that the market could pivot a number of different ways, but as long as it carries on in the way they're performing today, hedge funds should continue to perform positively for our investors. So overall, pleased to say, what a good story.

John Schlegel: Yes. I think it's been a very good story, not without some bumps here or there, we'll have to see where we go from here. But overall, I think there's some risk, but perhaps manageable for now. So thanks again, Kumar, for doing this with me and on a lovely London day. And yeah, it's great to see you as always.

Kumar Panja: Thanks, John. It was a lot of fun.

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