When Perry Corp. founder Richard Perry announced in 2016 that he was shutting down his main hedge funds after 28 years, he was well on his way to posting his third consecutive losing year. During that stretch he had seen his assets more than halve, to $4 billion as of September 30. The onetime Goldman, Sachs & Co. partner and arbitrageur made it clear that he had no interest in trying to steer a turnaround in a new environment. “Our style worked well for many years,” Perry wrote in a late September 2016 letter to investors. “Although I continue to believe very strongly in our investments, process, and team, the industry and market headwinds against us have been strong, and the timing for success in our positions too unpredictable.”
Perry’s departure marked the end of yet another prominent hedge fund. His announcement came one year after another former Goldman partner, Michael Novogratz, announced his retirement. The reason: After two consecutive annual losses, Fortress Investment Group had shuttered its Fortress Macro Funds, the liquid-markets business Novogratz had started in 2002.
Perry was part of a generation of hedge fund luminaries who launched legendary firms in the 1980s and 1990s but have suffered serious setbacks in the past few years, from brutal outflows of assets to sharp performance declines and even legal troubles. This group includes Paul Tudor Jones II of Tudor Investment Corp., Jamie Dinan of York Capital Management, Louis Bacon of Moore Capital Management, Leon Cooperman of Omega Advisors, Daniel Och of Och-Ziff Capital Management Group, Alan Howard of Brevan Howard, and Edward Lampert of ESL Partners.
Many professionals suffer down years and retire or simply walk away from their careers. But for hedge fund managers, 2016 was unusual for its sheer bad mojo. Last year the overall hedge fund industry suffered what was only its third-ever year of net redemptions. And 2016 was marked by near-apocalyptic pronouncements about the industry’s future, highly unusual public complaints from investors about steep fees (and low returns), and even admissions by hedge fund managers that they probably needed to rethink how much they charged.
The year also saw a number of venerable blue-chip hedge fund firms closed down or thrown on the defensive by an increasingly unforgiving market. “A culmination of different pressures hitting the market at once could likely lead some to step back from the business,” says David Saunders, chief executive and co-founder of K2 Advisors, a fund-of-funds firm that’s part of Franklin Templeton Investments. “This is something we have been talking about for a year and a half, and I feel we are at a unique juncture.”
Karim Leguel, head of client strategy and client portfolio management for Europe at JPMorgan Chase & Co., says veteran managers “made enough money, and now they’re letting the new guard in. Motivations might be changing, and they may want to run their own money.”
The fact is, this generation of blue-chip hedge fund managers grew up, established their reputations, and made their massive fortunes in a radically different era. They entered the hedge fund industry when a hedge fund manager needed only a relatively modest amount of capital (usually several hundred million dollars). They were not required to register with the Securities and Exchange Commission. Competition was thin, markets were relatively inefficient, wealthy individuals made up the bulk of their investors, and they received very little media attention.
“The model that generated alpha was by finding and exploiting inefficiencies,” says Charles Krusen, founder and CEO of Krusen Capital Management, the investment adviser to the LionHedge Platform Fund of alternative strategies, which includes hedge funds. “But now [inefficiencies] have been mapped out and modeled. There is just too much competition for those limited opportunities.”
Operating in the regulatory and media shadows, many hedge fund firms quietly cultivated a powerful mystique, driven by their ability to produce astounding returns: in many cases, 30 to 50 percent, or more, in a single year. In the 1980s and ’90s, three wildly successful firms served as the public faces of the growing industry: George Soros’ Soros Fund Management, Julian Robertson Jr.’s Tiger Management Corp., and Michael Steinhardt’s Steinhardt Partners.
From 1989 through 1995, in every year but one, Soros posted annual gains ranging from 30 to 70 percent. During that same period Robertson’s funds ratcheted up between 21 and 61 percent for six straight years, including gains of some 40 and 57 percent in 1996 and 1997, respectively. In the ’80s and ’90s, Steinhardt posted double-digit gains virtually every year, ranging from about 20 percent to more than 50 percent.
All three hedge fund icons charged a 1 percent management fee and a 20 percent performance fee on most of their funds, a relative bargain compared with the fees many funds charge today.
As more investors — mostly high-net-worth individuals — learned about these remarkable returns, they were willing to pay the steep fees to get in on the action.For example, investors gave SAC Capital Advisors’ Steven Cohen a 3 percent management fee and half their gains when he launched his firm in 1992, an arrangement he promptly justified by producing net returns of about 70 percent in 1999, the top of the Internet bubble, and 2000, when the market broke. Cohen’s flagship fund had compounded at 35 percent annually through 2007 and 30 percent annually by the time the government forced SAC to close in 2013; Cohen moved his assets to his family office, Point72 Asset Management. Remember, these returns were net of hefty fees.
Paul Tudor Jones, who founded Tudor Investment in 1980, established his reputation when he generated a 201 percent gain after correctly predicting the stock market’s October 1987 crash. Early on, he charged a 4 percent management fee and a 23 percent performance fee.
Macro legend Bruce Kovner generated 28 percent annualized gains for about 20 years after Caxton Associates’ launch, in 1983. In 1987 he racked up more than 90 percent returns in his two funds. In 2002, Kovner raised his management fee to 3 percent of assets and his performance fee to 30 percent.
All this took place before institutional investors, ranging from pension funds to endowments to sovereign wealth funds, flooded into the asset class seeking uncorrelated, absolute returns. The institutions saw hedge funds as a way to sail through market downturns taking minimal or no losses and reducing volatility. They did not demand or really expect hedge funds to generate outsize returns, though they didn’t expect red ink or below-benchmark returns either. Institutional money, in turn, spawned a proliferation of new hedge funds and the creation of a class of megafunds.
Then came the financial crisis and the protracted low-interest-rate environment that followed. Hedge funds began to find it more difficult to generate even modest returns unless they made bullish (and risky) bets on the stock market, which climbed for nearly eight straight years. For most of the past five or six years, many macro managers have posted anemic single-digit gains when they haven’t lost money. And long-short managers have seen losses on their short books slice into overall net gains.
This challenging new environment has baffled many blue chippers. Last year Jones wound up cutting 15 percent of Tudor Investment’s staff after suffering some $2.5 billion in redemptions. Part of the reason: His main macro fund, Tudor BVI Global, was on the way to its fourth low- to mid-single-digit return in five years, squeezing out a gain of just 1 percent in 2016.
Dinan’s York Capital Management, a multistrategy and event-driven firm founded in 1991, reported a $6.1 billion decline in assets last year — some 27 percent — from $22.3 billion to $16.2 billion. More than $5 billion of that sum reflected investor redemptions. York’s flagship multistrategy fund, York Capital Management, lost 1 percent in 2016, its second straight year in the red. Other York funds made money, including Credit Opportunities, up 4.2 percent, and Global Credit Income, up 14.6 percent, but the investor outflows continued. York also took a hit when partner Michael Weinberger, who had spent nearly 16 years with the firm, left to launch his own hedge fund. In the end, York had to reduce its fees.
Alan Howard’s U.K.-based Brevan Howard launched in 2002 and comes near the end of the blue-chip generation, but it also has been reeling from an asset drain. In the second half of last year, the Brevan Howard Master Fund saw some $4.4 billion leave, bringing the firm’s total assets under management to about $15.6 billion at year-end. That’s down roughly 34 percent from a year ago, when Brevan Howard managed $23.7 billion, and less than half the firm’s $40 billion at the beginning of 2014.
Brevan Howard had a particularly tough fourth quarter. In September the firm told clients it no longer will charge a management fee for existing investors in its flagship fund that invest additional capital, or on gains generated from existing money. However, the firm continues to cling to its 20 percent performance fee.
In October, Brevan Howard was one of seven hedge fund firms Rhode Island’s State Investment Commission tossed overboard as part of a decision to reduce exposure to hedge funds. For the year the firm’s main macro fund, the Brevan Howard Master Fund, posted a 3.2 percent gain — its first profitable year in the past three years. Most of the gains came in the stock rally that followed the U.S. presidential election late in 2016.
Louis Bacon’s Moore Capital Management also has been knocked back on its heels. Founded in 1989, the macro hedge fund firm suffered about $2 billion in redemptions last year; it trimmed the management fee for its $7.5 billion Moore Macro Managers Fund to 2.5 percent from 3 percent.
Last year Moore Macro Managers, which Bacon does not manage on a day-to-day basis, was flat after posting single-digit returns in three of the four previous years. The fund was down 3.8 percent for 2016 through October, only to be bailed out by the late-year rally. Moore Global Investments, the fund Bacon directly manages, benefited as well, posting a 6.1 percent increase for the year after gaining less than 1 percent through October.
Meanwhile, Edward Lampert’s ESL Investments has lost virtually all of its outside investors as a result of its large, ill-fated, and loss-plagued bet on Sears Holdings Corp., which today is a mere shadow of what was once — believe it or not — the largest retailer in the U.S. The Sears decline has been a story for Lampert for more than a decade.
To top all this off, dark clouds of scandal have shadowed Leon Cooperman’s Omega Advisors and Dan Och’s Och-Ziff Capital Management. Both New York firms saw their assets shrink dramatically in the past year as they struggled with serious legal issues.
In 2016, Och-Ziff’s assets tumbled by a quarter, to $11.1 billion, after several years of federal investigations into bribery cases in Africa. Och-Ziff, including its subsidiary OZ Africa Management, agreed in September to pay $413 million to settle SEC charges that it had violated the Foreign Corrupt Practices Act. In addition, CEO Och agreed to pay nearly $2.2 million to settle charges that he and CFO Joel Frank had “caused” violations of the FCPA. (Frank also agreed to settle.) Och-Ziff said it expected to enter into a deferred prosecution agreement with the Justice Department as part of a parallel criminal investigation.
The SEC has also dogged Omega, charging Cooperman and his firm with insider trading and other securities violations. Cooperman denies the charges and vows to beat the agency in court. Nonetheless, the investigation rocked the firm. Last year assets tumbled by nearly 50 percent, to $3.4 billion; they are down 64 percent over the past two years. It didn’t help that Omega Overseas Partners only posted a roughly 5 percent gain last year after suffering losses in each of the two previous years.
Of course, not all veteran blue-chip hedge fund managers are struggling. Many of them, in fact, are doing just fine, including Elliott Management Corp.’s Paul Singer, Millennium Management’s Israel Englander, Renaissance Technologies’ James Simons, Appaloosa Management’s David Tepper, and several of the early Tiger Cubs, including Lone Pine Capital’s Stephen Mandel Jr. and Viking Global Investors’ O. Andreas Halvorsen.
Many of these managers have successfully delegated most or all day-to-day money management to younger executives. Moreover, several of these firms, including Appaloosa and Lone Pine, frequently give money back to investors to maintain a size they feel allows them to maximize performance.
The question hanging over many of the blue-chip firms that suffered major redemptions is whether investors failed to give them the benefit of the doubt that their long track records deserved. Another way to look at this, however, is that investors may have factored the firms’ pasts into their decisions, and redemptions might have been even larger.
At least one prominent hedge fund allocator, Cliffwater’s Christopher Solarz, believes investors are penalizing blue-chip funds for their recent weak performance and discounting their long-term records. But he adds: “Investors have a right to be unforgiving. That’s why [the blue-chip firms] are paid the big fees. They are the best.”
“Every investor looks at it on their own terms,” says another major allocator. “Some people say, ‘Over the long term the firm made us a lot of money; I’m still confident.’ Others think their time has passed. All these firms are very big, with lots of resources and assets to support these resources.”
Nonetheless, their track records have been mediocre at best, for a lot longer than just a miserable 2016. The biggest names in macro investing — Tudor BVI Global, Moore Global Investments — have had low-single-digit gains in four of the past five years. Caxton Global Investment has posted a single-digit gain or a loss in four of the past five years. The Brevan Howard Fund has produced single-digit gains or losses in all of the past five years.
Part of the problem seems to be that the nature of the markets has changed, and the blue chippers have been slow to adjust. At the May 2014 Sohn Investment Conference, Jones told the audience, “Macro trading is as difficult as I have seen it in my career.” He blamed most of macro’s problems on central banks that had kept three-month interest rates at zero for several years and had raised rates just once in the previous 12 months. “Volatility is the tightest in years,” Jones added. “There are no interest rate movements.”
This, he explained, had created compression in markets such as equities, where volatility was at a multidecade low. Jones also noted that volatility was very low in foreign exchange markets. “It is hard when you depend on price movement to make a living and there is none,” he said.
Some hedge fund industry executives aren’t totally buying this argument. “Reading between the lines, they misjudged risk markets going straight up,” says one allocator to hedge funds. He says Tudor should have held S&P 500 index assets and high- yield credit, both of which rose sharply over the past few years. “They were too cute,” he adds. “Jones has more high-quality traders and economists than he’s ever had. He’s a seasoned trader. He’s much better than he was 30 years ago. He has the best processes.”
Some experts give Jones credit for being able to make any money over the past few years, unlike a number of macro managers, whose funds went out of business. And with rates starting to rise and volatility picking up in some markets, a smaller Tudor may be able to produce better returns.
“This has always been a young person’s business,” says Gregg Hymowitz, chairman and CEO of alternative-asset manager EnTrustPermal, speaking of the industry in general. “It is also our sense that it is hard to succeed when AUM is very large. If you’re doing it for 25 or 35 years, the past few years were not the most fun. So many are reevaluating and taking a step back.”
A problem for all hedge fund managers is the sheer size of the industry — the price of success. Many more managers are mining strategies and themes that years ago may have been arcane and overlooked. These days every trade seems like a crowded trade.?Kovner admitted as such when he was inducted into Alpha’s Hedge Fund Hall of Fame in 2008. The onetime commodity-trading adviser conceded that he formerly had benefited from a dearth of competition in the business. The flood of money that flowed into hedge funds spawned new firms and made it more difficult to exploit inefficiencies. “The crowded nature of the hedge fund community has changed the character of trading so that you can see waves of risk taking and de-risking coming from the hedge funds themselves,” he said. “When there were ten or 15 very active hedge funds, it didn’t matter what they did. When there are 10,000 hedge funds, it does matter. They move the markets. In addition, market opportunities get arbitraged out somewhat. Fifteen years ago I might have traded some things that we don’t trade at all now.”
Technology has also made it more difficult to generate long periods of high returns. Most hedge fund managers who entered the business after 2000 take for granted that they can access any information they want on a Bloomberg terminal or the Internet; this was not always the case.
Today computer-driven investors — quantitative firms — are among the fastest-growing hedge funds, and among the best performing. At the start of 2016, eight of the 12 largest hedge fund firms relied partially or totally on computers to make investment decisions. They include Two Sigma, founded in 2001 by John Overdeck, a mathematics whiz, and David Siegel, an expert in artificial-intelligence. Even discretionary-driven firms, which rely on humans to make investment decisions, are adding technology to the investing process in attempts to get an edge. Last year Jones himself ramped up the hiring of math and science Ph.D.s to help build out Tudor’s quant operation.
Hedge fund returns also have been hurt by the rising tide of money flowing into passive investments, especially exchange-traded funds. Many hedge fund managers blame ETFs for the difficulty long-short funds have experienced in their short books. Managers argue that ETFs cause mediocre companies to rise in tandem with better businesses within an industry because they’re included in the same index.
Despite all of this, a number of hedge fund investors and allocators remain optimistic about the future of blue-chip funds. They contend that shrinking assets will allow them to exploit what they believe will be increased market opportunities over the next few years. This is a theme Bacon stressed in his letter announcing the fee cut. “By reducing the management fee, we hope to maintain a stable asset base to capitalize on the many trading opportunities in the current environment,” he reportedly wrote to clients.
“We are getting into a period of greater uncertainty,” says a well-known allocator. “The opportunity set will be there when rates are not suppressed by central banks. In this environment these types of managers tend to do better. A smaller asset base may be a good thing. They are more nimble, and individual trades become more meaningful.”
Still, no one knows how many of the old hedge fund gang will stick around to see whether they can adapt to a new environment. To a man, they are hugely wealthy, may no longer want to deal with clients, and may simply opt to turn their firms into family offices. “You need 110 percent of your energy in this business,” a longtime investor in hedge funds stresses. “You lose your work-life balance. How long can you keep that up? Almost everybody has a number in terms of net worth. When they get there and it becomes a real hassle — clients yelling, losing key partners — they say ‘I’m out.’”
Adds EnTrustPermal’s Hymowitz: “The days of the star hedge fund guy may have faded. Many have deep benches with teams, processes. But there will always be a next wave of new talent.”
