Multi-manager hedge funds meet their maker
Three decades ago, when star traders such as George Soros, Julian Robertson and Paul Tudor Jones were masters of the universe, a new generation of firms began to crop up that looked different to their predecessors.
These funds hired a ton of specialist traders who were given their own profit-and-loss accounts and whose survival was predicated on the whims of the markets. While their trading was theoretically overseen by sophisticated risk management technology, any manager who sustained big losses could find themselves jobless.
The so-called multi-manager method was pioneered by Ken Griffin’s Citadel and Izzy Englander’s Millennium Management. The two launched their firms within a year of each other and still dominate the industry three decades later.
But the business model they pioneered is now at risk of becoming a victim of its own success, DD’s Ortenca Aliaj and the FT’s Harriet Agnew report in this Big Read, amid a fierce talent war and rising interest rates that eat into the healthy returns they’ve been able to deliver for investors.
Over the past five years in particular, multi-manager funds have emerged as the fastest growing and most profitable hedge funds on the scene.
Their diversified portfolios and ability to slash or raise their level of risk quickly gave them a key advantage during the pandemic when markets went into a tailspin.
But multi-managers often use huge amounts of leverage relative to their peers to juice returns — an average of more than five times their assets, by Goldman Sachs’ calculations — on the guise that they can oversee risk.
That hasn’t meshed well with higher interest rates, which have increased the cost of borrowing and forced funds to spend more money on producing the same outsize returns.
And given that these funds utilise a so-called pass-through expenses model, aka when a manager passes on all costs to their end investors rather than an annual flat fee, investors aren’t too jazzed about shouldering the extra costs.
The platforms’ rapid growth in recent years and a scarcity of the kind of specialised risk-takers who can handle the job has also unleashed a fierce battle for talent, driving pay for top traders sky-high and footing investors with the bill.
One hedge fund investor outlined the fate of multi-managers into two scenarios: either “someone gets pummelled . . . or they lose their edge”.
An uptick in “crowded trades” means these funds are inextricably linked whether they like it or not. A trade gone wrong could ripple across the market. Or, in a less dramatic turn of events, the strategies become so mainstream that profits become unsustainable.
Even Griffin, whose last year topped Bridgewater’s Ray Dalio as the most successful hedge fund manager of all time, acknowledged that the end of an era may be on the horizon.
“Clearly right now the multi-strategy managers are very much in vogue. When you’re most popular is probably when you’re reaching the top of the cycle,” he told the FT.