Hedge funds move from the margins into the mainstream
As hedge funds have evolved from tiny pools of private capital to hulking investment houses, so too have their clients.
Some hedge funds are now larger than those of conventional “long-only” asset managers – and much more complex.
Hedge fund investors used to be rich individuals seeking higher returns. But today, according to Towers Watson, the consultancy, more than a third of hedge fund assets come from pension funds seeking to diversify by placing money in “alternative” assets.
As many large hedge funds run several investment strategies simultaneously, determining their risk profiles has become more difficult. “The number of sub-strategies is huge,” says David Barenborg of BlackRock, one of the world’s largest allocators to hedge funds.
Calpers, the largest US public pension fund, recently decided hedge funds had become too complex and costly and withdrew its $4bn investment.
For Max von Bismarck, partner at SkyBridge, which has $10bn in hedge funds, alternative investment vehicles help manage risks, as they are not correlated with the rest of its portfolio.
Yet this argument has been tested, as hedge funds pursue similar strategies, potentially amplifying losses even within a diversified portfolio. Several funds lost money when highly valued technology shares they held fell.
Coatue Management, run by Philippe Laffont, saw its flagship fund fall 8.7 per in March after being burned by a reversal in technology shares, but later managed to recover some of its losses later in the year.
A number of hedge funds were hit by betting on the outcome of several large takeovers during the summer, such as 21st Century Fox’s offer for Time Warner, and Sprint’s attempt to buy T-Mobile US. The collapse of these deals wrongfooted several funds that specialise in trading on takeover situations, known as risk arbitrageurs, or “arbs”. The resulting “Arbageddon” was a further reminder to investors of the dangers of investing in hedge funds that are all chasing the same trades.
More recently, a number of large hedge funds made bets on so-called “inversion” mergers, where US companies buy a rival domiciled in a country with a lower tax base.
As the Obama administration has become more vocal about stopping this practice, arguing that it is an abuse of the US tax system, the shares in companies involved in inversions have gyrated, leading to a choppy time for the many hedge funds that own them.