How Revolutionary Hedge Funds Shaked Things Up
Super-wealthy hedge funds managers Izzy Englander, Ken Griffin, Steve Cohen are killing it. Their mimics are struggling to stay up.
Because they were the first to use what is now the most popular approach in the hedge fund sector, the big three have a leg up on the competition: Multimanager firms distribute capital among numerous specialist investment teams, often numbering in the hundreds, in an effort to provide more stable returns that are not linked to general market fluctuations. The concept of a hedge fund as the brainchild of a single manager is turned on its head by their approach.
Last year, Point72 (Cohen), Millennium Management (England), and Citadel (Griffin) all had returns of 10% or above. Although this is lower than the 26% return (including dividends) of the S&P 500 last year, it is common practice for hedge funds not to measure their performance relative to the market as a whole. Making money is their ultimate goal, regardless of the market conditions. Research company HFR reports a 7.5% return for a broad hedge-fund index last year.
When compared to the return any investor may get from simply depositing money into a bank account and earning interest, the competitors of the top three had a hard time keeping up. Balyasny Asset Management’s flagship fund ended the year with a 2.7% return. The primary fund of Schonfeld Strategic Advisors increased by around 3%. The Minnesota-based Walleye Capital returned approximately 4%. A 2.9% return was achieved by the primary fund managed by London-based LMR Partners.
Despite the fact that the hedge fund industry has had relatively slow asset growth over the past many years, massive quantities of capital have poured into multimanager firms. Barclays reports that multimanager funds’ assets increased dramatically from $185 billion in 2019 to $350 billion in 2018. They are more like an institution than a trading business, which is why they are appealing to large institutional investors like endowments and pensions.
Due to the big three multimanager firms closing its doors to fresh capital, the recent rise has been observed among copycats. Unfortunately, very few of the entrants have equalized the achievements of the old guard.
The scale and financial resources of Citadel, Point72, and Millennium have been significant factors in their success, according to investors and management. According to bankers and investors, the largest firms have the means to recruit top-tier portfolio managers with guaranteed salaries, venture into uncharted territories like commodities trading, and upgrade their risk management and investment identification capabilities through the use of cutting-edge technology.
One of Franklin Templeton’s divisions, K2 Advisors, which manages over $10 billion in client funds for hedge funds, “The leaders have an advantage,” according to Rob Christian, chief investment officer. “They command the resources (infrastructure, tech, data, connections to Wall Street, talent pipeline, risk management, etc.).”
It would seem that the prevailing knowledge among hedge funds is at odds with the big three’s success. When they were smaller, hedge funds had a hard time replicating their returns. Using smaller sums of money at a time typically led to successful trades. On the other hand, rivals learned trade tactics quite fast.
The three biggest hedge-fund firms in the world—Citadel, Millennium, and Point72—manage a combined $60 billion, or about $32 billion, of client capital. In the preceding year, after deducting expenses, Citadel’s flagship Wellington fund returned 15.3%, Point72 gained 10.6%, and Millennium returned almost 10%. Although these companies are tight-lipped about their profitable investments, Citadel reportedly made money off of its stock and bond wagers, according to a recent report in The Wall Street Journal.
The first hedge fund, started approximately 75 years ago with $100,000 in seed money by journalist and sociologist Alfred Winslow Jones, is dwarfed by today’s multimanager behemoths. The idea behind his groundbreaking yet simplistic strategy was to profit from price increases or decreases in the market by purchasing assets at a discount and selling them short when he believed they were overpriced.
In the decades that followed, the business was ruled by star traders who gambled heavily with concentrated bets. An estimated $100 million was made by Paul Tudor Jones of Tudor Investment Corp on Black Monday in 1987, and George Soros’s business generated $1 billion in profits in 1992 from betting against the British pound. John Paulson’s business won $15 billion in the early 2000s after betting against the US housing market. This was one of the larger payouts of the 2000s.
About 30 years ago, the first multi-manager organizations came up with the original A.W. Jones method. Beginning with a so-called market-neutral strategy that seeks to profit from rising and falling markets, they implement it across a multitude of investment teams, frequently with a hyper-focus on particular sectors or securities. With these teams’ semi-autonomous operation, the likelihood of dispersed bets and more steady returns is increased. They are aiming for singles, not home runs.
The emphasis on risk management is a selling element for many multimanager organizations. Extreme situations can involve minute-by-minute tracking of performance and extremely competitive demands, such as “cut your losses quickly” or face dismissal from the company.
Ten Edges Capital’s founder, Sherban Tautu, described the funds that have proven to be good at managing risk as “the stabilizers.” The firm serves clients, including wealthy families, and specializes in hedge funds.
“These managers won’t aim for the stars,” he continued, “but they are the ones we can rely on to provide a steady return of 5–10% annually.”
A lack of strategic breadth has been a problem for many rising stars, including those who are direct descendants of the top three. Companies like Citadel, Millennium, and Point72 have the advantage of being able to operate numerous investment methods, such stock picking and macro trading, simultaneously. The returns for multimanager firms that operated four or more strategies last year were nearly twice as high as those for firms that concentrated in just one strategy, according to a recent Barclays poll.
The interest of investors in these hedge funds will be tested this year by new multimanager startup funds. Robert Kim, who was the chief investment officer of AllianceBernstein’s multi-manager product, Fortress Investment Group, and Jonathan Xiong, who was the co-CEO of Millennium Asia, are all planning major new launches.
Ex-Chief Investment Officer of Millennium Bobby Jain is planning to start a multimanager firm called Jain Global in July. According to sources familiar with the situation, Jain has lowered performance fees for investors who committed a specific amount of money or signed on by a specific date. The discounts are most pronounced for investors who pledged $250 million or more. These kinds of benefits are sometimes extended to a select group of early investors.
Setting up new multimanager funds is appealing in part because of the higher-than-usual fees they can demand. Instead of charging investors 2% of the fund’s assets and 20% of its profits, as was the case with the previous “two-and-20” structure, multimanager firms now charge investors the operational costs of the funds, including technology and signing bonuses.
A Barclays investor survey found that under this so-called pass-through fee arrangement, investors typically pay charges equal to about 5% of fund assets plus performance fees. According to the bank’s findings, expenditures might sometimes exceed 7% of assets.
Additionally, investors are sometimes asked by multimanager businesses to keep their money locked up for longer periods of time. Take Millennium as an example; once investors opt to withdraw their money, it now takes five years to fully remove it.
According to Marlin Naidoo, global head of capital introduction at BNP Paribas and a specialist in introducing investors to hedge funds, investors had little power to resist the terms demanded by multi-managers due to the strategy’s ravenous demand in recent years.
According to Naidoo, things are beginning to shift, particularly because newer companies aren’t performing up to par with the industry leaders.
“We may have reached a point where the power dynamic is more balanced, but not necessarily in favor of the investor,” Naidoo remarked.
