Friday, March 15, 2013

Treacherous Times For Hedge Funds?

Dan McCrum and Sam Jones of the Financial Times report, Hedge fund closures keep rising:
The number of hedge funds going out of business rose for the third year in a row in 2012, according to HFR, a data provider. Last year, 873 funds failed or closed their doors out of the estimated 9,800 total, against 775 in 2011 and 743 in 2010.

Those closures were offset by 1,108 new hedge fund launches, slightly down on the 2011 total. The pace of launches has recovered from the low of 659 funds in 2008, but the rate still lags behind the boom years of 2004 to 2007.

“The environment for launches remains very difficult,” said Anne-Gaelle Pouille, a director for Paamco, a fund of funds group that specialises in small hedge funds with less than $1bn in assets at launch.

Ken Heinz, HFR president, said that for the average hedge fund, “the last two years have been a wash. If you look at the whole HFR Index, you are barely up over a two-year period”.

The average hedge fund gained 6.4 per cent in 2012, after average losses of 5.3 per cent in 2011. A simple portfolio of index funds invested 60 per cent in US stocks and 40 per cent in bonds was up 17.5 per cent over the same two year period.

Mr Heinz said that “costs are going up and the requirements on funds in terms of regulatory reporting are also going up”.

Reflecting that tough environment, fees charged by newly launched hedge funds came under pressure. Annual management fees charged by new launches held steady at 1.62 per cent on average, according to HFR, but the performance fees that managers charged on investment profits dropped 34 basis points on the year before to 17.74 per cent. Pre-crisis, performance fees on new launches peaked at 18.7 per cent.

Some high profile funds attracted significant capital and support. London-based Mike Stewart, JPMorgan’s global head of proprietary trading, and former head of emerging markets, launched Whard Stewart with a team of former traders from the bank.

Stone Milliner, led by Jens-Peter Stein and Kornelius Klobucar, spun out of Moore Capital. And Sutesh Sharma, the former head of proprietary trading at Citigroup launched Portman Square Capital with about $500m.

But Ms Pouille said that most funds were offering fee discounts at launch. “There has been a proliferation of what’s called founders classes”, with up to 5 percentage points off performance fees, and reduced management fees, in return for committing capital for two or three years.
Zero Hedge notes that most hedge funds are underperforming the S&P 500 for a fifth year in a row, providing a report from HSBC's Alternative Investment Group listing the best and worst funds.

Indeed, these are treacherous times for hedge funds. The stock rally, low fixed-income yields, plateauing commodities and legal pressures have mired hedge funds in uncertainty, raising questions amid growing frustration by many investors.

Hedge fund Darwinism is a recurrent topic on this blog. None of this shocks me or anyone else investing in hedge funds. In December 2011, wrote about how most hedge funds were on the ropes, struggling to survive. Have also covered the rise and fall of hedge fund titans, warning investors not get all giddy on yesterday's hedge fund "superstars."

Think the most important thing to keep in mind when discussing hedge funds or private equity funds is that the averages mean nothing. Most hedge funds stink. Period. The same can be said about private equity and even mutual funds, although the latter don't charge 2 & 20 fees when they underperform markets (still outrageous how mutual funds rape retail clients on fees).

Also, in hedge funds (and private equity), there tends to be performance persistence among top funds which are regularly tracked every quarter. And even though smaller hedge funds outdid their elite rivals in 2012, they have been hardest hit by the global financial turmoil that has made it more difficult to raise money from investors since the collapse of Lehman Brothers Holdings Inc. in 2008.

Among the hedge funds that are surviving and doing well, compensation is going up:
Hedge fund professionals are enjoying fat wallets once again. Their average cash compensation rose 15 percent to $314,000, according to the 2013 Hedge Fund Compensation Report. In addition to analyzing the salaries and bonuses of hundreds of hedge fund pros, the yearly report also examines the impact of fund performance and size on earnings, hiring trends, and job satisfaction.

Fueled by strong fund performance, bonuses contributed strongly to the year-over-year increase in total pay in 2012. The average hedge fund bonus surged by 31 percent, while the mean base salary edged up 4 percent.

“This year, we discovered a significant correlation between fund profitability and bonus size,” said David Kochanek, publisher of 2013HedgeFundCompensationReport.com. “Employees of the best-performing funds took home average bonuses of just over $200,000.”

Kochanek continued, “Given similar performance, we expect 2013 bonuses to rise even further as many funds will reach their high-water mark.”
Firm size had little bearing on compensation, with similar earnings reported by employees from the smaller funds as those from firms with $1 billion under management.

Hiring trends remained roughly on par with the previous year, with 24 percent of firms reporting hiring within research departments, 20 percent adding to operations, and 12 percent seeking to bolster legal departments.

The full report, available for download, contains more than 40 detailed charts and graphs. It provides comprehensive data to help hedge fund professionals set goals and negotiate compensation packages, and assist firms seeking to establish pay benchmarks.
A bit surprised that "firm size had little bearing on compensation" as the 40 highest-earning hedge fund managers all come from large funds. That just means the top guys keep the lion's share of the profits.

In terms of their latest performance, Kelly Bit of Bloomberg reports, Paulson Drops as Hedge Funds Fall 0.4% in February:
Hedge funds fell 0.4 percent last month, trailing global stocks, as funds including those at John Paulson’s Paulson & Co. and Ray Dalio’s Bridgewater Associates LP posted declines in February.

Multistrategy and macro managers decreased last month, while long-short equity hedge funds rose, according to data compiled by Bloomberg. Hedge funds that gained in February include Steven A. Cohen’s SAC Capital Advisors LP and Renaissance Technologies LLC, founded by Jim Simons. Hedge funds on average rose 1.5 percent this year.

The MSCI All-Country World Index, which has beaten the $2.25 trillion hedge-fund industry in five of the past seven years, rose less than 0.1 percent in February, including dividends, as markets swung between concern and optimism about economic growth. Stocks worldwide fell on Feb. 25, when the Italian election stalemate reignited worries about Europe’s debt crisis. The Dow Jones Industrial Average climbed to the highest level in five years just two days later on better-than-estimated housing data, before hitting a record in March.

“Most strategies were up but dragged down by macro (BBHFMCRO) and multistrategy,” said Don Steinbrugge, managing partner of Agecroft Partners LLC, a Richmond, Virginia-based firm that advises hedge funds and investors. “The economic readings continued to be positive, especially in the housing market. The economic information out of Europe was not as good as the U.S.”

The Bloomberg Hedge Funds Aggregate Index is down 10 percent from its July 2007 peak. The main Bloomberg hedge fund index is weighted by market capitalization and tracks 1,264 funds, 2,763 of which have reported returns for February. The index, with annual data dating to 2006, has fallen short of the MSCI benchmark each year except for 2008 and 2011.
Paulson, Bridgewater

Long-short equity funds, whose managers can bet on and against stocks, rose 0.3 percent in February, bringing yearly gains to 2.3 percent. Multistrategy (BBHFMLTI) funds fell 0.6 percent last month and gained 0.8 percent this year. Macro funds, whose managers make investment decisions based on their reading of economic and political events, declined 1.2 percent in February, paring returns in 2013 to 0.1 percent.

Paulson posted an 18 percent decline in his Gold Fund last month as a slump in the metal, after more than a decade of gains, undermined efforts by the billionaire hedge-fund manager to rebound from two years of losses in some strategies.

The $900 million Gold Fund, which invests in bullion- related equities and derivatives, is down 26 percent this year, Paulson & Co. said yesterday in a client update obtained by Bloomberg News. The $18 billion firm’s Advantage funds also fell in February, while its dollar-denominated Recovery, Credit and Merger funds posted gains. All of the gold share classes of the funds declined.
SAC, Renaissance

Bridgewater Associates’ Pure Alpha II fund fell 2.6 percent last month through Feb. 27 and 2.4 percent this year, according to a person familiar with the matter. Dalio’s Westport, Connecticut-based firm manages $140 billion in assets.

Cohen’s SAC Capital International increased 0.9 percent last month, bringing gains in the first two months of 2013 to 3.4 percent, said a person with knowledge of the matter who asked not to be identified because the information isn’t public. The fund is run by SAC Capital Advisors, the $15 billion Stamford, Connecticut-based firm that was notified in November by the U.S. Securities and Exchange Commission that it may be sued for insider-trading fraud.

Renaissance Technologies, the $22 billion East Setauket, New York-based hedge fund, posted a 2.2 percent February gain in its Renaissance Institutional Diversified Alpha Fund, bringing yearly returns to 4.5 percent, according to a person familiar with the matter. The Renaissance Institutional Equities Fund, advanced 2.3 percent last month and 7 percent this year, said the person, who asked not to be identified because the returns are private.
Hutchin Hill

Hutchin Hill Capital LP, the $1.1 billion hedge fund founded by Neil Chriss, posted a 2 percent advance in February in its Hutchin Hill Diversified Alpha Master Fund, bringing yearly gains to 4.9 percent, according to a person familiar with the matter.

Och-Ziff Capital Management Group LLC (OZM), the New York-based hedge fund run by Daniel Och, posted a 0.4 percent February gain in its OZ Master Fund, bringing its yearly return to 2.8 percent, the firm said in a regulatory filing. The OZ Europe Master Fund advanced 0.3 percent last month and 3.7 percent in 2013. The OZ Asia Master Fund climbed 0.4 percent in February and 4.1 percent this year. Och-Ziff had about $34.6 billion in assets as of March 1, a $1.5 billion increase from a month earlier, the firm said in the filing.
Tudor’s Returns

Tudor Investment Corp., the $12.1 billion global macro hedge fund founded by Paul Tudor Jones, rose 1 percent last month through Feb. 22 in its Tudor Global Fund, bringing yearly gains to 5.3 percent, according to a person familiar with the matter.

Pine River Capital Management LP, the $12.8 billion firm based in Minnetonka, Minnesota, posted a 0.3 percent return in its Pine River Fixed Income Fund run by Steve Kuhn, bringing yearly gains to 6.1 percent, according to an e-mail to clients, a copy of which was obtained by Bloomberg News. The Pine River Fund run by Aaron Yeary climbed 0.8 percent in February and 5.4 percent in 2013, the firm said in a separate e-mail.

Hedge-fund assets grew 2.8 percent to a record in the fourth quarter, according to Chicago-based Hedge Fund Research Inc. Investors deposited $3.4 billion during the period, the firm said in January.
More trouble for the Paulson Disadvantage Minus Fund but apart from gold, which was set for a massive pullback after people realized there is life beyond Grexit, like some of his latest moves in coal and other sectors. Wouldn't count Paulson out just yet.

As for the perfect hedge fund predator, these are the markets that Steve Cohen and his crew over at SAC Capital absolutely love. Insider scandals aside, as the bull market that gets no respect keeps making new record highs, Cohen, Cooperman, Tepper and a few other elite fund managers are posting solid gains.

As for Ray Dalio and Bridgewater, I've already expressed my views that I don't think they're in deep trouble but they are experiencing growth issues. What remains to be seen is if global macros who were revived by Abenomics will continue seeing profits as central banks print money.

And even though Renaissance is coming back, which I predicted, large quant funds are chopping fees in half, and with good reason. Interestingly, there has been very little discussion on fees among institutional investors. Great news for private equity behemoths expanding into hedge funds as standard private equity loses its luster. Pension flows into alternatives has been a boon for their shares.

The news in the fund of funds world is mixed. Financial Risk Management Ltd., a unit of the world’s largest publicly traded hedge-fund manager Man Group Plc (EMG), may see the best return from its multistrategy funds of funds since 2009, but UBS O’Connor LLC, the $6 billion hedge-fund unit within the biggest Swiss bank, risks upheaval as senior traders seek to defect after a clampdown on cash bonuses. They're not the only ones bracing for bonus curbs.

Finally, was speaking to a hedge fund manager earlier this week who is trying to seed his tail-risk strategy. Unlike others, he has better ideas on how to approach hedge funds from an asset allocation viewpoint and realizes the limits of tail-risk strategies.

He told me he listened to a presentation on hedge funds from Citigroup this week which was excellent (read the June 2012 report here). Most pension funds (65%) are now going direct into hedge funds but they're increasingly relying on consultants who suffer from group think. "The consultants use Bridgewater's All-Weather approach to allocating to hedge fund strategies but that's leveraged beta and leaves them vulnerable to getting the macro call wrong (they are not Ray Dalio). "

He notes that pension funds piling into hedge funds and private equity as a way to dampen volatility are better off with the standard 60/40 equity/ bond split and allocating a percentage to a well-constructed tail-risk strategy which doesn't bleed them 2 percentage points every month. "The key is to get an asymmetric payoff when you really need it without costing you a lot of basis points in the interim."

He thinks the next crisis will be a lot harsher than 2008 as hedge funds and banks engaging in illiquid trades will have to "sell their side-pockets," basically level-3 crap they have on their books which only they and a few others are able to price.

He notes this: "...it's actually not as bad as that, stock pickers are punished in this environment because correlations going to 1. Translation, they can't find good shorts: rising tide lifts all boats, especially junk boats so they end up running 50% net long and still underperform but this is a sign of a very unhealthy market under the hood, not a healthy one so pension funds should be aware of rising risks, not falling ones."

But he also agrees with me that as stocks keep making record highs, the pressure will grow on money managers to jump into the market to make up for underperformance. This can create a waterfall moment as the liquidity dam breaks and high beta stocks melt up. He told me: "There is a guy from Pimco who like you thinks investors are worried about the wrong side of tail-risk."

We shall see which side eventually wins out as hedge fund managers are bearish and bullish on China. I'm still bullish on coal, copper, and steel but must admit so far my lump of coal for Christmas has been very volatile, anemic and has yet to pay off handsomely (think it will as global growth comes back strong).

Institutional investors looking  for truly independent advice on hedge funds and private equity funds should contact me directly at LKolivakis@gmail.com. I'm now available to discuss consulting mandates. As always, please donate generously to this blog on the top right-hand side and click on the ads you see as it provides additional revenues to support my efforts. I thank you in advance.

Below, Bloomberg's Erik Schatzker and Stephanie Ruhle examine the top hedge fund managers of 2012 as Lone Pine Capital's Stephen Mandel and Appaloosa Management's David Tepper rose above the pack. They speak on Bloomberg Television's "Market Makers."

And John Paulson posted an 18 percent decline in his Gold Fund last month as a slump in the metal, after more than a decade of gains, undermined efforts by the billionaire hedge-fund manager to rebound from two years of losses in some strategies. Kelly Bit reports on Bloomberg Television’s "Money Moves."

Lastly, as Steve Cohen's SAC Capital paid $600 million to settle insider trading charges, Bob Rice, general managing partner with Tangent Capital Partners LLC, discusses hedge funds attempts to stop insider trading. He speaks on Bloomberg Television's "Money Moves."