Friday, August 29, 2014

Avoid the Hottest Hedge Funds?

Lawrence Delevingne of CNBC reports, Why you should avoid the hottest hedge fund hands:
Investors who don't have money with Pershing Square Capital Management are likely salivating at the hedge fund's industry-leading 26 percent return from January through July.

But investing with Bill Ackman and other top-performing managers after a great run is probably a bad idea, according to a new study of long-term hedge fund industry performance.

A white paper by Commonfund, which manages nearly $25 billion for close to 1,500 endowments, pensions and other institutions, shows that putting money with the hottest hedge fund managers can work in the short term, but that sticking with them for three years or more is worse than picking managers at random. Picking up losing hedge fund strategies can even produce slightly positive performance.

"Not only does positive-return persistence tend not to work as a selection strategy, but it is especially ineffective in the medium-to-long-range horizons that institutional investors may prefer, and indistinguishable from a strategy of selecting losers," authors Kristofer Kwait and John Delano wrote.

Kwait and Delano found that picking winning hedge funds produced returns of 13.29 percent after 18 months, versus an average of 10.62 percent for all funds. But the same group held for 36 months gained the same as the average; over 48 and 60 months, they rose just 9.49 percent and 8.48 percent, respectively.

In theory, hedge fund allocators could invest with the best managers and then quickly cash out within 18 months. But the vetting and subscription process to get in can take months or even years, especially for cautious institutional investors. Plus, hedge funds often require that their investors commit money for at least a year, and then restrict redemptions by spreading them out over several quarters.

Commonfund said its findings were consistent with a point made by Cliff Asness of AQR Capital Management.

The hedge and mutual fund manager has written that investors often try to catch short-term results in various asset classes but use a multiyear time frame, which often means they instead get hit with losing reversals—or miss winning ones—when the trade inevitably reverts to the mean. Asness declined to comment on the Commonfund study.

Ackman, for example, underperformed stock indexes in 2013 with a 9.3 percent gain, hurt by losses on J.C. Penney (JCP) and a short position on Herbalife (HLF). But Pershing Square has rocketed back this year with wins on Allergan, Canadian Pacific, a reversal in fortune for Herbalife and others, according to a recent letter to investors.

Another famous example of a hedge fund reversal is Paulson & Co. John Paulson saw his client base increase dramatically after he scored huge returns with bets against the housing market before it crashed. But heavy losses in 2011 and 2012 from too-early bets on the U.S. economic recovery caused investors to pull their money (Paulson's hedge funds snapped back in 2013).

The study also found that teasing out manager skill, or "alpha," from the general market ups and downs, or "beta," is critical to selecting hedge fund managers who will outperform.

"For an allocator, that this relationship between observed alpha and skill is not necessarily certain may leave a door open for inferring a sort of skill even from beta-driven returns, perhaps on the basis of a hard to define but powerful argument that a manager is 'seeing the ball,'" the paper noted.

The Absolute Return Composite Index, which aggregates hedge fund returns across all strategies, gained 3.79 percent this year through July. By comparison, the S&P 500's total return was 5.66 percent and Barclays Aggregate Bond Index gained 2.35 percent.

The challenge is parsing out what alpha really is; hedge fund managers are quick to attribute their gains to skill rather than market forces.

Large investors—and their teams of advisors—appear convinced they can draw the distinction. No less than 97 percent of 284 institutional investors surveyed recently by Credit Suisse said they plan to be "highly active" in making hedge fund allocations during the second half of 2014. That's even more than the 85 percent who already made allocations in the first half of the year.

According to industry research firm HFR, investors allocated $56.9 billion of new capital to hedge funds in the first half, pushing total global assets to more than $2.8 trillion, surpassing the previous record of $2.7 trillion from the prior quarter.
No doubt about it, the big money still loves hedge funds. You should all take the time to read the white paper by Commonfund, which is truly excellent.

And just to add evidence to the findings of this white paper, Michelle Celarier of the New York Post reports, Hedge funds’ all-wet profits nothing to party about:
The mood in the Hamptons isn’t likely to be too celebratory this Labor Day weekend for most hedge fund honchos.

With late August numbers starting to trickle in, some of the biggest stars are barely breaking even. Others are in the red in a year when the broader market is up 8 percent.

Take David Tepper, who turned in an astonishing 42 percent in 2013 to take home $3.5 billion.

That’s not likely in 2014 as his hedge fund was only up 2.3 percent through July, the latest numbers available. The fund fell 1 percent that month.

Richard Perry, another veteran star, is up a mere 1.3 percent through Aug. 22 — after falling 1.4 percent this month. Perry Partners gained 22 percent in 2013.

Leon Cooperman, always a bull market darling, had gained 2.25 percent for the year through July. His Omega Advisors fund rose 30 percent in 2013.

Nelson Peltz of Trian Partners is faring a bit better. His fund gained 6.6 percent through Aug. 22, with 1.9 percent coming in August. But last year, Trian was up 40 percent. That earned him a spot on the Top 20 list — alongside Tepper — published by HSBC.

Jeff Altman’s Owl Creek, which rose to fame last year with a 48.6 percent gain, has done an about face. The former top 20-hedge fund fell 3 percent through Aug. 22, with 2 percent of the loss in August.

Hedge fund legends Paul Tudor Jones and Louis Bacon are also in the red. Bacon’s main fund is down 5.5 percent through Aug. 14, after booking a 1.3 percent loss the first two weeks of the month.

Jones, meanwhile, has fallen 3 percent this year, following a .4 percent loss in the first three weeks of August.

I can't say I'm shocked by the findings. A long time ago, I wrote a comment on the rise and fall of hedge fund titans, where I wrote the following:
...I will tell you Paulson's rise and fall is nothing new. I've seen it many times before. Typically, hedge funds have a great track record, or an incredible year, consultants and brokers start spreading the word to institutional investors and in no time assets under management explode up.

That's when your antennas should go up and you need to start thinking of pulling out. Whenever I see assets explode up, from $5 billion to $40 billion, I pay very close attention because it usually spells trouble ahead.

That's exactly what happened with Paulson. He was riding the coattails of his outsized returns, assets under management mushroomed and returns subsequently faltered. Seen this so many times and yet the institutional herd keeps piling onto yesterday's winners like moths to a flame.
Should you always add more when a hedge fund or external manager gets clobbered? Of course not. Most of the time you should be pulling the plug way before disaster strikes. You need to look at the portfolio, assets under management, people, process, and risk management and make a quick decision.

This isn't easy but if you don't, you'll end up holding on and listening to a bunch a sorry ass excuses as to why you need to be patient. And no matter who he is, I would never accept any hedge fund manager 'chiding' me for redeeming from their fund. That's beyond insulting, but in an era where hedge fund superstars are glorified, this is what routinely happens.

Been there, done that, it's a bunch of BS. The media loves glorifying hedge fund managers but the bottom line is all these 'superstars' are only as good as their last trade. Institutional investors should stop glorifying these managers too and start grilling them hard.

The problem is too many institutions don't have clue of what they're doing when it comes to investing in hedge funds or private equity, so they end up listening to the useless advice of their brainless investment consultants.

I know that might sound harsh but it's the truth which is why I continuously poke fun at how dumb the entire hedge fund love affair has become. Sure, there are some good consultants, but the bulk of them are totally useless.

I used to go to these silly hedge fund conferences where institutional investors were getting all hot and horny over hedge funds and think to myself what a total waste of time. Most of these people don't have a clue of the underlying strategies and more importantly the risks of these strategies.

So what do they end up doing? They all chase performance, getting bamboozled by some hedge fund manager with his head up his ass, telling them to "hurry up and invest because they are setting a soft close at $X billions and a hard close $Y billions."

I used to get phone calls all the time when I was managing a portfolio of directional hedge funds at the Caisse. The pressure tactics were a total joke. I ignored third party marketeers and any arrogant hedge fund manager who was trying to pressure me into investing.

I recall my first meeting with Ron Mock at Teachers back in 2003 when he explained his hedge fund strategy and the way they allocate and redeem. Teachers was and remains very active in hedge funds. I recall specifically asking him about redemptions and how hedge funds react. Ron told me flat out that while "most hedge funds don't like it, if you do it in a professional manner, they'll understand and won't take it personally."

I also asked him what happens if they threaten not to allow him to invest with them ever again or if they act arrogant with him? He told me: "I have no time for arrogance and typically what happens in this industry is when the tide turns, the arrogant managers come back to plead for money. I've seen it happen many times. When they need money, they will come back to you and embrace you with open arms."

And even Ron Mock, who I consider to be one of the best hedge fund allocators in the world, experienced a few harsh hedge fund lessons in his career as a hedge fund manager and as an allocator. Following the 2008 crisis, Ontario Teachers now invests the bulk of their hedge fund assets into a managed account platform (they use Innocap), but they still invest a small portion in less liquid hedge funds (the flip side of transparency is liquidity; no use putting an illiquid hedge fund onto a managed account platform).

Allocating to external managers isn't easy, especially when you're dealing with overpaid and over-glorified hedge fund managers. This is one reason why there is a hedge fund revolt going on out there, led by CalPERS which announced it was chopping its hedge fund allocation back in May and recently confirmed it was rethinking its risky investments.

Most investors, however, aren't backing away from hedge funds. Instead, they're rethinking the way they allocate to hedge funds. For example, co-investments are entering the hedge fund arena. And Katherine Burton of Bloomberg reports, Hutchin Hill, Citadel See Assets Jump as Pensions Call:
Neil Chriss is hitting his stride.

The math doctorate turned hedge-fund manager founded Hutchin Hill Capital LP more than six years ago and built it to cater to large investors. After posting annualized returns of 12 percent, about six times the average of his peers, he finds himself in the sweet spot for fundraising. Hutchin Hill’s multistrategy approach is the most popular hedge fund style this year, helping the New York-based firm double assets by attracting $1.2 billion.

Chriss, 47, is one of the prime beneficiaries as investors are on track to hand over the most cash to hedge funds since 2007, driven by a search for steady returns and protection from market declines. The biggest firms, such as Citadel LLC, Och-Ziff (OZM) Capital Management Group LLC and Millennium Management LLC are bringing in the biggest chunks of money, yet a select group of smaller firms like Hutchin Hill have collected more than $1 billion each.

“There are huge sums of money being put to work,” said Adam Blitz, chief executive officer at Evanston Capital Management LLC, an Evanston, Illinois-based firm that farms out $5 billion to hedge funds. “You are getting some big checks coming into a fairly small universe of brand-name managers who want to grow and are on the approved list of hedge-fund consultants.”

Hedge funds attracted a net $57 billion in the first half of this year, compared with $63.7 billion for all of 2013, according to Hedge Fund Research Inc. Ten firms, including Hutchin Hill, gathered about a third of that amount, investors in the funds said.
Assets Swell

Industry assets have swelled to a record $2.8 trillion even though funds, on average, have posted 7 percent annualized returns since the financial crisis, compared with 12 percent over the previous 18 years, according to the Chicago-based research firm.

Inflows are coming from pension plans, sovereign wealth funds and high-net worth investors. Some of the institutions, such as the Hong Kong Jockey Club, are making direct investments in hedge funds for the first time, rather than going through funds of funds. The club, which controls horse-racing in the city, said in April it gave money to Och-Ziff and Millennium.
Multistrategy Popularity

Multistrategy firms, which use a range of tactics to invest across asset classes are the most popular this year after collecting a net $29.5 billion, according to Hedge Fund Research. The funds returned 4.4 percent through July 31, compared with 2.5 percent for hedge funds overall.

“Pension funds see multistrategy hedge funds as a one-size-fits-all investment,” said Brad Balter, head of Boston-based Balter Capital Management LLC. “It’s very difficult right now to identify attractive opportunities, so they are letting the manager make the tactical decisions rather than wait for their own investment committees to re-allocate capital.”

Hutchin Hill, which employs more than 60 investment professionals, uses five main strategies, including equities, credit and one that makes trading decisions based on quantitative models.

Chriss’s goal is to provide better and more consistent returns than he might using just one approach. His background is in computers and math: He taught himself to program at age 11 and sold a video game to a software company when he was a high-school sophomore.
Lured Away

After obtaining his Ph.D. from the University of Chicago, he was lured away from a teaching job at Harvard University in 1997 to go to Wall Street. He set up his firm in 2007 after working for Steve Cohen’s SAC Capital Advisors LP with early backing from Renaissance Technologies LLC founder Jim Simons.

Hutchin Hill has gained 8 percent this year, according to a person with knowledge of the performance, who asked not to be identified because the results are private.

While firms like Hutchin Hill are beginning to climb the ranks of multibillion-dollar managers, the domination of the biggest funds in raising assets hasn’t slowed, even when they report bad news or post mediocre returns.

Och-Ziff, the biggest U.S. publicly traded hedge-fund firm with $45.7 billion under management, pulled in a net $3 billion into its hedge funds this year, even as it warned shareholders that the Securities and Exchange Commission and the U.S. Department of Justice were investigating the firm for investments in a number of companies in Africa. Its main fund returned 2 percent in the first seven months of the year, less than half the average of multistrategy funds tracked by Bloomberg.
Sovereign Wealth

Chicago-based Citadel, run by billionaire Ken Griffin, helped spark a backlash against multistrategy funds after it lost 55 percent in 2008, one of the worst hedge fund declines stemming from the financial crisis. Six years later, its $22 billion in assets have surpassed its previous peak in 2008.

Its main hedge fund, which is up 9.9 percent this year, has pulled in a net $1.2 billion in 2014, even though it’s limiting inflows primarily to sovereign wealth funds, according to an investor. The firm’s Global Fixed Income fund, run by Derek Kaufman, attracted $2.7 billion.

Millennium, founded by Israel “Izzy” Englander, has collected a net $2.6 billion this year, after only taking in enough money to replace client withdrawals in 2013. The New York-based firm, which manages $23.5 billion, decided to raise money again because it’s adding more teams to the 150 that currently work at the firm. The fund has climbed about 4.2 percent this year and has posted an annualized return of 14.6 percent since January 1990, said investors, who asked not to be named because the fund is private.
Balyasny Assets

The popularity of the multimanager, multistrategy approach that Millennium helped pioneer a quarter-century ago has been a boon to some smaller managers. Dmitry Balyasny’s Chicago-based Balyasny Asset Management LP attracted $1.5 billion this year, bringing total assets to $5.9 billion, while Jacob Gottlieb’s New York-based Visium Asset Management LP pulled in $700 million into its multistrategy fund this year, after raising $1 billion in 2013.

Event-driven funds, which include managers who take activist roles at the companies in which they invest, continue to attract investors this year as the strategy gained 6 percent through July.
Loeb, Solus

P. Schoenfeld Asset Management LP climbed to $4.1 billion in assets as clients invested a net $1 billion and Solus Alternative Asset Management LP attracted $1.25 billion. Dan Loeb’s $15 billion Third Point LLC, which is known for taking activist positions, had been closed to new investments since 2011 and returned capital last year. It recently told investors it would open Oct. 1 for a limited amount of capital that clients expect will be about $2 billion, they said.

A few start ups have also received a billion dollars or more this year, in part because they are coming out of firms with strong track records that are closed to new investments. Herb Wagner, who started FinePoint Capital LP this year and raised $2 billion, was a co-portfolio manager at Baupost Group LLC, the Boston-based firm run by Seth Klarman. Matthew Sidman opened Three Bays Capital LP, another Boston firm, in January and is now managing $1.2 billion. He worked at Jonathon Jacobson’s Highfields Capital Management LP for 14 years.

Spokesmen for all the firms declined to comment on inflows and performance.

Big Money Raisers 2014

Firm PM Net AUM

Citadel Ken Griffin $3.9 bln $22.0 bln
Och-Ziff Dan Och $3.0 bln $45.7 bln
Millennium Israel Englander $2.6 bln $23.5 bln
FinePoint Herb Wagner $2.0 bln $ 2.0 bln
Balyasny Dmitry Balyasny $1.5 bln $ 5.9 bln
Solus Chris Pucillo $1.25 bln $ 4.6 bln
Hutchin Hill Neil Chriss $1.2 bln $ 2.5 bln
Three Bays Matthew Sidman $1.2 Bln $ 1.2 bln
Passport John Burbank $1.0 bln $ 3.9 bln
P. Schoenfeld Peter Schoenfeld $1.0 bln $ 4.1 bln
It looks like I'm going to have to update my quarterly updates on top funds' activity to include new funds and to reclassify others. For example, Visum used to specialize in healthcare stocks and Balyasny was a L/S Equity and global macro fund. Now they've rebranded themselves as multi-strategy shops because they see the potential of garnering more assets.

I suspect you'll see more and more funds rebranding themselves into multi-strategy shops to boost their assets under management and start collecting that all important 2% management fee on multi billions. The name of the game is asset gathering which is understandable but also troubling.

I like managers like Neil Chriss and think he has the potential of being another great multi-strategy hedge fund manager. I'm not worried about Ken Griffin or Izzy Englender as they have proven track records and still deliver great results despite their enormous size.

But I'm warning all of you, even these great multi-strategy shops are not immune to a severe market shock and most of them got clobbered in 2008 and some made matters worse by closing the gates of hedge hell. Of course, Citadel came back strong, as I predicted back then because most fools didn't understand why the fund was hemorrhaging money, but it doesn't mean that it can't suffer another major setback.

When you're investing with hedge funds, you really need to have a smart group of people who can drill down into their portfolio and understand the risks and return drivers going forward. Stop chasing returns, you'll get burned just like those who blindly chase the stocks top hedge funds are buying and selling.

By the same token, don't invest in hedge fund losers thinking they're going to be tomorrow's winners. Volatility in commodities is shaking up many hedge funds in that space and I expect this trend to continue. Some will adapt and survive but most will close up shop.

It doesn't matter which fund you're investing with, you've got to ask tough questions and grill these managers. If they start acting arrogant or cocky, grill them even harder. I mean it, don't be intimidated and don't fall in love with some hedge fund manager because he's a billionaire and fabulously wealthy. Trust me, you're just a number to them and that's exactly what they should be to you.

Finally, while many of you are getting ready to write a big fat ticket to your favorite hedge fund manager, I kindly remind you that I work very hard to provide you with timely and frank insights, so take the time to click on the donation or subscription buttons on the top right-hand side. You simply aren't going to find a better blog on pensions and investments out there so please take the time to show your appreciation and contribute.

Below, a couple of clips providing a rare glimpse Citadel, one of the best multi-strategy hedge funds that is also the world's biggest market maker (h/t, Zero Hedge). For better or for worse, quants have forever changed the landscape of the investment management industry (see my comments on the Wall Street Code and the Great HFT Debate).

And Gregory Taxin, president of Clinton Group Inc., talks about hedge-fund investor Bill Ackman's plan to raise money in a public sale share this year of his Pershing Square Capital Management LP. Taxin speaks with Betty Liu on Bloomberg Television's "In the Loop.”

I've got an emerging manager up here in Canada who I think has the potential to be a really great activist manager if someone is willing to step up to the plate and seed him. I can't share details on my blog but if you're interested in discovering a real gem, email me at and I'll put you in touch with him. Enjoy your long weekend and please remember to contribute to my blog.

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