Fund managers and institutional investors have turned pessimistic on the hedge fund outlook, forecasting returns for 2014 will average out at half those of 2013.

The majority of respondents to a survey by alternative asset research firm Preqin believe the 2014 All Hedge Funds benchmark will fall between 4-6%, against the 11.69% return for 2013.

In the first half of 2014 the industry has underperformed the previous two years. As of June 30, the All Hedge Fund benchmark has posted net returns of 3.68%, of which the majority (2.33%) was recorded in the second quarter.

In December last year a resounding 73% of fund managers said they had a positive outlook for 2014, but by the middle of this year that had fallen to 57% for the second half of this year.

Over the same period, those in the neutral camp increased from 26% to 39%, and those who said they were negative rose from 1% to 4%.

“Hedge fund managers and investors entered 2014 in a buoyant mood following two years of double-digit returns and large inflows of fresh capital from investors,” said Amy Bensted, head of hedge fund products at Preqin.

However, she acknowledged that generating attractive returns – a key requirement from both fund managers and investors – had proven to be a challenge for hedge fund managers so far this year.

“In turn, 2014 could be shaping up to be a watershed year for the industry; new regulations, a continued challenging fundraising environment and a start to the year which has seen the All Hedge Fund benchmark in the red as many times as the black are undoubtedly posing challenges to hedge funds,” she said.

Bensted noted that not only did hedge fund managers need to focus on strategy to improve returns, but also on their business from a compliance perspective as well as improving their reach in the institutional investment community in order to thrive in the second half of the year.

The survey found that 53% of fund managers and 51% of hedge fund investors believe the 2014 year-end benchmark return will fall between 4-6%.

On the whole, investors were slightly more positive than fund managers: 10% of investors forecast that the industry would make overall gains of 10% or more, compared with 7% of managers.

North American managers were more optimistic than global peers, predicting a mean benchmark return of 6.06%, versus 5.89% for counterparts from Asia and the rest of the world, and 5.33% for European peers.

Overcoming poor performance was among the top three challenges cited by all fund managers across the globe for the second half of this year. This was the most important challenge cited by 28% of managers from Asia and the rest of the world.

In Europe and North America, regulation and a challenging fundraising environment were seen to pose more of a challenge.

In Europe, 38% of fund managers reported regulation as the key challenge, while a quarter of North America-based managers said the same about fundraising.

Preqin interviewed 150 fund managers and institutional investors globally in June to ascertain their outlook for the hedge fund industry in the second half of 2014.