Hedge funds will shape up to be a portfolio diversification tool and a means of generating returns this year, the bank predicted.

The drivers behind the recent disappointing performance of hedge funds are set to flip in 2016, pulling investors back into the alternative asset class, according to Societe Generale Private Banking Hambros.

The past few years have seen poor performance from alternative investment managers when comparing with the period leading up to the financial crisis. The average performance level from the late 1990s to 2007-2008 was 7 per cent and this was down to 2.1 per cent from early 2010 to 2015, according to the HFRXGL Global index.

The bank highlighted a number of reasons for the decline, including falling dispersion and correlation between assets, which make it a challenging environment for trend followers, as well as low volatility and zero-interest rate policies. 

“As US interest rates begin to normalise, we expect all these factors to gradually reverse and translate into better returns from hedge funds,” said Alan Mudie, head of investment strategy at SGPB Hambros.

A recent report by Hedge Fund Research showed a jump in dispersion towards the end of last year. The top decile of the HFRI Fund Weighted Composite Index increased by 23.4 per cent, while the bottom decile declined -29 per cent, resulting in a decile dispersion of +52.4 percentage points, up from the +46.9 percentage point dispersion a year earlier.

The predicted brighter outlook for the industry echoes recent research from multi-family office Stonehage Fleming, which found that the younger generation of ultra-high net worth families favour alternatives and hedge funds far more than their parents when it comes to wealth preservation and growth.