Hedge Funds Are Hot Again. Good Luck Finding One That’ll Take Your Money
(Bloomberg) -- Confined to their desks in the midst of the global pandemic, former Citadel traders Niall O’Keeffe and Tio Charbaghi made the rounds on video calls to woo investors for their new hedge fund.
It should have been a hard sell. The price tag was high for a fledgling fund — a 20% cut of profits on top of a hefty 2% annual fee. The investment style, betting on rising and falling stocks, was out of vogue with investors. The pitch was uncompromising: take it or leave it.
And yet, the duo raised $1.25 billion, the most by a hedge fund so far this year. On their first day of trading on July 1, they slammed the doors shut to new investors.
It’s a feat that’s rare even in a $4 trillion industry replete with superlatives, marking a hedge fund resurgence after a decade-long decline. But it holds a stark message for investors trying to get in on the nascent boom: it may already be too late to put money to work with the most promising money makers.
There are signs everywhere showing how rapidly the shift has occurred. Famed investment firm Brevan Howard, which as recently as mid-2019 was struggling to stem an unprecedented client exodus, shut its flagship fund to investors earlier this year. Christophe Aurand, the former co-chief investment officer of York Capital Management who is planning to raise a new $1 billion hedge fund, is already mulling closing it by the end of the year, according to people familiar with the matter.
Across the industry, a record 1,144 hedge funds have stopped accepting new money, the most since data tracker Preqin started compiling the information. Of twenty multi-manager firms managing more than $220 billion collectively, thirteen are no longer taking in more cash, according to Julius Baer Group Ltd. Crucially, those closures are happening at some of the biggest and sought-after firms.
“The reality is the best performers are dictating terms,” Ivan Iliev, head of alternative funds at Julius Baer, said in an interview. For investors, “the easy way of making money by buying two or three multi-manager platforms is closed,” he said, referring to the the practice of investing with a handful of hedge funds that give clients access to an array of strategies.
Of course, only a small fraction of the 8,000 or so hedge funds globally are in a position to be demanding. Average fees are continuing to fall for the vast majority of managers after a lengthy stretch of lackluster performance in the years following the global financial crisis, which brought an end to an earlier era of standout returns and explosive growth.
The post-crisis slump hit the industry hard. A brutal culling prompted more than 11,600 hedge funds to shut between 2008 and 2020. While hedge funds collectively doubled assets to more than $3 trillion through 2020, not a penny came through net inflows, according to an analysis of data from Hedge Fund Research Inc. In recent years, active managers struggled to beat cheaper index trackers, with many firms blaming central bank intervention as a key factor in sapping markets off their volatility.
But volatility returned as the pandemic roiled markets last year, spurring resurgent returns at some top funds. That in turn has created an extreme and unprecedented dislocation in the industry, widening the divide between the most coveted hedge funds and everyone else. The upshot is that an elite cadre of managers are set to extend their dominance in an industry where 90% of the assets are already controlled by just 20% of the world’s hedge funds.
No hedge fund has mirrored the arc of the industry’s fortunes more faithfully than Brevan Howard, the London-based investment firm co-founded by billionaire Alan Howard. The firm, once one of the world’s largest hedge funds, entered into a prolonged slump after assets peaked at more than $40 billion in 2013. Over the next several years, anemic returns prompted investors to yank their investments, bringing assets crashing down to about $6 billion at their low point in 2018.
Dozens of staff were fired, fees were cut and the firm shuttered many funds. Speculation swirled that Howard — who made his name as an interest-rates trader — would follow peers like George Soros and Michael Platt to turn his firm into a family office and return all outside capital back to investors (The firm said the rumor wasn’t true).
As Howard turned away from managing his firm in 2019 to focus solely on trading, he brought in Chief Executive Officer Aron Landy to oversee other changes. Traders with ambitions to run their own money pools were given funds to manage, driving an upswing that produced returns of as much as 99% last year. That’s allowed the firm to boost assets to more than $16 billion and double fees on its listed fund.
“The tables have turned in favor of managers dictating the terms,” Caron Bastianpillai, who allocates money to hedge funds at Switzerland-based Notz Stucki & Cie, said.
Blue-chip firms such as Elliott Investment Management and Millennium Management are pushing clients into share classes that require investors to lock in their money for longer periods of time. Even funds of hedge funds, the middlemen between money managers and investors, which were tainted by the Bernie Madoff scandal during the financial crisis, have pulled in cash this year after persistent outflows since 2008.
Other hedge funds, especially those that seek to profit from macroeconomic events, joined Brevan Howard in benefiting from large-scale market disruptions last year. Chris Rokos, a Brevan Howard co-founder who went on to start his own hedge fund, posted returns of 44% in 2020, his best year ever, and Caxton Associates climbed 42%. Millennium returned 26%, the firm’s best year in two decades.
As a group, hedge funds are off to their best start since 1999 after posting their biggest gains in a decade in 2020. Industry-wide assets, which had stagnated for years, surged past $4 trillion, according to data compiled by Preqin. Hedge funds optimism about their own businesses is also on the rise, according trade body AIMA, which surveyed money managers running about $1 trillion.
“Last year, although the market rebound was fast, the stress test was very deep and hedge funds performed the way investors wanted,” said Mark Jones, the soon-to-be deputy chief executive officer at the world’s largest listed hedge fund firm Man Group Plc. “That’s a material positive tick for clients.”
The recovery is visible at Man Group: Its assets have hit a record $135.3 billion and shares have surged more than 50% this year, double the gain in the world’s biggest asset manager BlackRock Inc.
A lot could still go wrong. A fresh round of Covid infections may yet upend positions that rely on an economic rebound. Tech stocks, one of the main contributors to returns, could reverse their upward trajectory. China’s crackdown of its industry leaders could spark selloffs.
The unraveling of Bill Hwang’s leveraged bets at Archegos Capital Management and Gabe Plotkin’s precipitous decline after a short-squeeze spurred by Reddit traders also highlight the idiosyncratic risks that could derail any rebound.
For now, investors are overlooking those risks. Ex-Citadel traders O’Keeffe and Charbaghi were able to point to their record investing in industrial and tech stocks in their seven years at billionaire Ken Griffin’s investment firm. Their firm, FIFTHDELTA, was deluged with client money even as investors have been pulling money out of long-short strategies.
Meanwhile, Aurand — who left Jamie Dinan’s York Capital last year — is on track to start trading stocks for his firm Nekton Capital in London shortly and will close it to fresh cash by the end of the year. Representatives for Aurand and FIFTHDELTA declined to comment.
To Saleem Siddiqi, who has seen the evolution of hedge funds over much of the last two decades, the investor stampede harks back to the frenzy at the turn of the century, which built the foundation for a boom until the 2008 crisis reversed the trend.
“It’s deja vu all over again,” said Siddiqi, who runs Musst Investments in London.
At Brevan Howard, the firm is determined to avoid a repeat of the boom-and-bust cycle. And a key part of that is talking more to investors, who in the old days didn’t get much more than an occasional update and a phone call. Now, even with Brevan Howard firmly in the throes of a turnaround, it’s focused on holding onto client assets when markets inevitably turn again.
“The issue is with the ability of the manager to stop investors from getting disillusioned and retain their confidence during inevitable periods of not-so-great performance,” Landy said in a virtual interview from his home office. “What we are doing very thoughtfully and deliberately is trying to be the best partners for our clients.”
For him and other senior money managers at the firm, that means grabbing a microphone: they all have to record podcasts outlining the thinking behind their investments.
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