A handful of giant firms are gaining dominance over the hottest corners of the hedge fund industry. This year showed why.
While nearly all hedge fund indexes are negative, a closer look at the data shows that multi-strategy and macro funds with the biggest concentration of investors’ cash posted gains, shielding clients from a ferocious selloff in global markets as central banks began raising rates and rolling back years of quantitative easing.
Giants from Citadel to Millennium Management produced double-digit gains as their army of traders once again earned steady returns. Those betting on macro economic trends, such as $5 billion Haidar Capital and $15.5 billion Rokos Capital Management, are poised for record annual gains.
“2022 is a tale of bifurcation on all aspects,” said Nicolas Roth, head of alternative assets at Geneva-based private bank Reyl & Cie. “From performance, asset raising to hiring, big hedge funds roared back, while small guys are struggling.”
Both critics and fans have plenty of material this year for arguments in support of or against the $4 trillion industry.
For detractors, another lousy year for stock pickers was best captured by Tiger Global Management hedge fund’s 54% slump after its bets on stocks and private assets imploded. The $75 billion of net outflows from the industry is another indication that many investors now view hedge fund fees as no longer worth paying.
Yet supporters could point to rising demand for the most coveted funds. To gain access, many are now accepting fees that can rise to many times traditional hedge fund charges and are willing to lock away their investments for longer. Others are being turned away as the funds close their doors to new money.
For the year ahead, the stage is now set for a robust test of the industry.
Rising interest rates and a deteriorating global economy have upended the trading environment. While the new volatile scene has created fertile hunting grounds for credit and equities traders, managers will have to keep their wits about them to avoid blow ups.
“Next year is almost the perfect setting for a hedge fund strategy,” said Mario Unali, a senior money manager at Kairos Partners that invests in hedge funds. “You get higher rates, you get more volatility, you get fundamentals that are back in business and it’s not going to be all about passive investments.”
The top three money pools investors want to allocate to in 2023 are macro, credit and equity, according to a survey released this month by industry tracker Preqin.
Here’s an analysis of the industry through a series of charts and data:
The Good
Nine in every 10 dollars invested in macro hedge funds gained 23.7% on average through September this year, while 95% of the capital allocated to multi-strategy investment firms eked out gains, according to a Bloomberg analysis. By comparison, a 60/40 portfolio of stocks and bonds slumped almost 21% and the S&P index declined by about 25%. Hedge funds on average lost 9% during the period.
Citadel’s flagship Wellington fund surged 31% through November this year, DE Shaw Composite gained 23%, while Millennium advanced 10%. Among macro hedge funds, the Haidar Jupiter fund soared 194%, Rokos made 45% and Brevan Howard’s main hedge fund gained 18%.
Yet, investors’ reaction have been mixed. While clients have bolstered their investments in multi-strategy hedge funds, they have pulled money from macro strategies to the tune of $26 billion, more than five times the net outflows in 2021. This contrasts with previous years when investors typically chased performance and inflows followed periods of good returns.
Macro hedge funds produced gains by betting on trades benefiting from spiraling inflation and central banks’ response to contain it. Short wagers on bonds and equities were profitable, while long wagers on commodities made money.
“Moving forward, we believe that returns will remain robust but normalize, as easy trades have already been realized by managers,” Preqin analysts wrote in the hedge fund tracker’s annual report.
Meanwhile, business is booming at multi-strategy investments firms that rely on dozens of traders making bets across asset classes.
They have been able to hire the best talent, even luring some well-established managers running their own single strategies with the promise of sticky capital, robust trading infrastructure and fat compensation packages.
Powering the firms’ ability to poach the best traders is the adoption of the so-called pass through fee structure. The fee can cover everything from boosting pay to hiring, to covering rent and even entertainment. While management fees were traditionally set at an annual rate of 2% of assets, the pass-through charge isn’t set and can climb to 10% or more.
Recently, Ahmet Arinc, the former head of foreign exchange trading at Deutsche Bank AG, shut down his hedge fund after four years to join bigger rival ExodusPoint Capital Management with his team.
Stock picker Heron Bay Capital also shut and its investment team led by founder Sean Gambino joined multi-strategy hedge fund peer Eisler Capital. Eisler itself is winding down its first hedge fund and ditched plans to start another fund to focus entirely on its multi-strategy money pool.
Such is the growth in the strategy, multi-strats are on the cusp of taking over equity long/short hedge funds as the most dominant money pools in the industry.
Hedge funds relying on computer-driven algorithms also generally profited from the wild swings in global markets. Soaring volatility and rising rates sparked major trends across fixed income, currencies and commodities market, providing opportunities to the algorithms designed to profit from any sustained rise or fall in asset prices.
“Quant macro strategies can thrive in this environment and make meaningful gains for clients, which has been particularly valuable in a year which has been so challenging for most asset classes,” said Mark Jones, deputy CEO of Man Group Plc that runs some of the biggest such funds. “We’d expect higher macroeconomic volatility to persist into next year and that usually bodes well for these strategies.”
These hedge funds won a big following after their roaring success through the 2008 global financial crisis when they produced double-digit gains as everything else failed. They are staging a comeback from years of mediocre gains amid muted volatility caused by quantitative easing.
The SG Trend Index, which measures returns of some of the largest quant funds in the world rose by almost 26% through Dec. 9, just shy of its best annual gain in 2002.
Some of the biggest quant funds including Aspect Capital’s Diversified, Man AHL Alpha, Systematica’s BlueTrend and The Winton Fund have produced double-digit gains. The strategy is home of the highest concentration of funds producing returns in excess of 10%, according to data compiled by Preqin.
“Simply put, quants nailed the inflation trade,” said Andrew Beer, founder of New York-based Dynamic Beta Investments, which attempts to replicate hedge fund-type returns at a low cost. “While humans hummed and hawed about whether inflation was transitory or had peaked, quants piled in early and just rode it.”
The common link between the best performers was their size. While smaller funds enjoy a theoretical edge that helps them move in and out of positions more easily, investors have been largely migrating toward bigger players for steadier gains and reduced business risk.
The fortunes of bigger funds is vitally important for investors: Just a fifth of hedge funds manage 90% of the industry assets, according to data compiled by Hedge Fund Research Inc.
The Bad
The net $75 billion of outflows from the industry occurred in the year through October and that number may swell as 2022 draws to a close and investors rebalance their portfolios.
Equity-focused hedge funds suffered the biggest exodus as investors lost patience with yet another year of poor performance. Such money pools were down an average of about 12% through November, according to data compiled by Bloomberg, close to the 14% decline in the S&P 500 Index during the period.
By geography, investment firms based in Europe suffered most of the outflows, while those based in the US, the biggest market for hedge funds, were largely shielded. A Preqin analysis revealed that better returns at North America-focused and based funds are driving investors into them in contrast with relatively poor returns at Europe-based managers.
“North America still holds the crown when it comes to median allocations to hedge funds,” Preqin said in its report.
The Ugly
Overall, the industry’s growth has almost stagnated. This year is on track to see the least number of hedge fund startups globally since Preqin started compiling the data in 2000.
While it may be an indication of a maturing industry, the trend also signals a notoriously difficult capital raising environment for hedge funds as investors place their cash with the bigger, more established firms. Traders who could have started their own firms, and even those already running their small funds, are giving up and joining bigger rivals.
The crowded equity-focused hedge funds market, where more than 4,000 managers operate, was the hardest hit: roughly 42% of the hedge fund liquidating through September this year wagered on stocks.
And the reasons are obvious. Stock pickers had a tough year and they failed to capture most of the upside during the recently ended bull market but have suffered the most during the ongoing sell off. More than six in every 10 equity hedge funds lost 10% or more through September, their worst showing compared with their own recent past as well as against their peers’ performance, according to data compiled by Preqin.
2023 is “kind of a make or break year,” Caron Bastianpillai, who allocates money to hedge funds at Switzerland-based Notz Stucki & Cie, said. “If you have two years in a row where hedge funds underperform, I think people are just going to give up.”
Bloomberg News provided this article. For more articles like this please visit
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