Why Hedge Fund Selection Matters More Than Ever

Periods of market euphoria often encourage excessive risk-taking, the consequences of which only become apparent when the cycle turns.

Earlier this year, in our article Hedge Funds: 2026, the Year of Discipline, we argued that risk management would be one of the key differentiators in 2026. Looking back, that assessment appears to have been well founded.

For hedge fund selectors, 2026 has generally been a constructive year. Yet the environment has been anything but straightforward. Geopolitical tensions, the conflict involving Iran, persistent political uncertainty in the United States and the growing concentration of investment flows around artificial intelligence have created particularly demanding market conditions.

Equity long/short managers have, on the whole, generated positive alpha. Until the end of the second quarter, results were supported by sound sector allocation and effective stock selection. July, however, marked a sharp reversal. According to Goldman Sachs Prime Brokerage, it was the most destructive month for alpha generation since January 2022.

In an environment characterised by extreme market concentration, even highly disciplined managers struggled to avoid simultaneous losses on both long and short positions, despite the MSCI World Index ending the month in positive territory. The situation was further amplified by the collapse of a hedge fund heavily exposed to the artificial intelligence theme. Its concentrated and highly leveraged portfolio failed to withstand margin calls, triggering forced selling that reverberated across the broader hedge fund industry.

This episode serves as a reminder of a simple but critical reality: when markets become dominated by only a handful of investment themes, manager selection becomes increasingly important. Moments of euphoria often encourage excessive risk-taking, while the consequences tend to emerge abruptly when sentiment shifts.

At the same time, the hedge fund industry has attracted substantial inflows over the past five years. Several high-profile managers now oversee more than USD 100 billion in assets, while many multi-strategy platforms have experienced remarkable growth. At that scale, delivering differentiated performance becomes increasingly challenging. Maintaining a selective approach is therefore essential in order to avoid future disappointments.

We continue to favour two areas in particular: niche managers with limited capacity and strategies that still offer meaningful alpha potential, especially in Asia and within certain quantitative approaches.

Dispersion Creates Opportunity

Global Macro strategies have also experienced significant performance dispersion this year. In a volatile environment, the strongest managers have demonstrated an ability to manage risk effectively while adapting rapidly to changing market conditions. We continue to see particular merit in macro strategies given the economic and geopolitical uncertainties that remain. Access to the most talented managers, however, remains difficult and represents a meaningful advantage for investors with long-standing relationships across the industry.

Perhaps the most encouraging development this year has come from Asian long/short equity managers, particularly those focused on China. These managers successfully captured a meaningful share of the upside related to artificial intelligence while simultaneously reducing exposure during periods of market weakness. Their ability to adapt resulted in significant alpha generation while providing valuable diversification within portfolios.

Hedge Fund Selection Remains the Key Driver of Alpha

The hedge fund landscape continues to offer a wide range of opportunities, but manager selection and ongoing monitoring remain the primary drivers of long-term success. While private banks and investment platforms increasingly facilitate access to many of the industry’s best-known names, that is only part of the equation. The most compelling opportunities are often found among less widely known managers with limited capacity, specialised expertise and a genuine competitive edge. It is precisely in this segment of the market that active manager selection continues to create value.

Written by Cédric Dingens

Read the original French article published in AllNews:
Hedge Funds: la sélection fait toute la différence

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