Hedge Funds Born to Run?
Pension funds’ love affair with hedge funds is cooling off.As I stated last Friday in my comment on hedge fund Darwinism, the hedge fund industry is becoming increasingly more competitive and many funds will not survive the brutal shakeout.
They yanked a collective $6.4 billion from hedge funds in October, the third month this year they have pulled out money, according to a new Trim Tabs/Barclay Hedge report released yesterday.
Although pensions have handed $15.7 billion directly to hedge funds so far this year, that’s still a far cry from last year’s $78.5 billion and $65.7 billion in 2010.
This year’s retrenchment is a bad omen for hedge funds, whose asset growth has been bolstered by direct institutional investment from pension funds in recent years. Since the crash of 2008, these funds — primarily heavily under-funded state and local government pensions — have bypassed funds of funds and put their money directly into hedge funds, hoping to goose returns.
But for the past three years, hedge funds have under-performed the broader market while insider trading scandals continue to plague the industry.
“These institutional investors are not only taking investment risk, they’re taking career risk and headline risk,” said one hedge fund manager, explaining pension funds’ newfound skittishness.
A case in point is New Mexico’s public pension plan, which had been a leader in hedge-fund investment. In October, the fund said it was pulling money from hedge giants including Eric Mindich’s Eton Park and Bruce Richard’s and Louis Hanover’s Marathon Asset Management. Before that, it withdrew money from Paulson & Co., one of the worst-performing hedge-fund firms this year.
New Mexico later decided to reduce the amount of money it allocates to hedge funds by about $300 million, according to Institutional Investor’s Alpha.
New Mexico had also been one of the many public pensions that had invested in Diamondback Capital Management, which last week told investors it was shutting down due to a flood of redemptions in the wake of an insider-trading scandal.
Diamondback founders, who hailed from Steve Cohen’s SAC Capital Advisors, were not charged, but one former employee has pleaded guilty and a second is on trial.
The New York State Common Retirement Fund, which had invested $252.3 million in Diamondback as of March 31, has also pulled its money from the fund.
What concerns me is that as investors pull out of hedge funds, they have to wait to get their cash back:
Some investors in hedge funds will have to wait to have part of their investments returned in cash.Nothing investors love more than getting gated by some hedge fund charging them 2 & 20, losing money! Sadly, most investors haven't checked their redemption clauses and have forgotten all about the financial crisis when hedgies closed the gates of hedge hell.
Alden Global Capital's Alden Global Distressed Opportunities Fund LP, known for snapping up stakes in media and publishing companies, told investors that redemption of a portion of their investments would be delayed.
According to a letter reviewed by Reuters, Alden Global Capital has put some of its clients' redemption requests into a sidepocket, effectively restricting immediate access to some of their money. "A portion of your withdrawal request for the August 31 withdrawal date will be placed into an Alternate Withdrawal Account," said the letter, dated that day.
The restriction, which has not been previously reported because the fund is private, follows on the heels of a difficult 2011 when the fund, founded by vulture investing specialist Randy Smith, suffered losses of more than 20 percent.
Alden has been a major investor in media companies including Tribune Co, Philadelphia Media Network and A.H. Belo Corp, and said proceeds from assets put into the sidepocket would be distributed within 12 months of the time they were put in.
Restricting investors' full access to their money has always created a stir in the hedge fund industry. "You are certainly inconvenienced even though you may not be damaged," said Ken Phillips, chief executive of HedgeMark, which helps investors construct hedge fund portfolios and manage risk. "Effectively all of your choices have been taken away."
To be sure, restrictions on redemptions, sometimes also called gating or sidepocketing, are not occurring with great speed this year, industry analysts said, noting that these types of moves were seen mainly during the financial crisis. "We are not hearing a lot about it," Phillips said.
But any move to restrict access is noteworthy, particularly if it coincides with heavy redemption requests after a period of poor performance. It often suggests that funds are invested largely in hard-to-sell assets.
According to an investor survey conducted by consulting group Aksia, hedge fund managers reported that 72 percent of their clients have not changed their preferences on liquidity terms. But managers said that 17 percent of investors wanted greater liquidity, while 11 percent would accept lower liquidity.
Hedge funds, unlike mutual funds, traditionally lock investor money for many months and sometimes even years. They also often have clauses in their documents allowing them to restrict access even more sharply if they feel that is necessary.
Other firms that have recently limited access include Salient Partners LP, which cut the withdrawals investors can make from its Endowment Fund. Investors are now able to pull out only 5 percent of their money by year's end because a chunk of the fund's investments are in less liquid assets, the group said recently.
Perella Weinberg Partners' $1.4 billion Xerion Fund also recently told investors about a small twist in how they will get their money back.
Dan Arbess, who delivered gains to Xerion investors during the financial crisis and has long made successful bets on private investments, told investors that the bulk of redemptions will be made in cash. But investors will have a choice to receive a small portion returned as an interest in one the fund's private positions or to allow Arbess to manage it until a sale is made on their behalf, according to a person familiar with the fund.
The fund is up roughly 8 percent this year but suffered losses in 2011, which helped prompt the redemptions. "The move is certainly not a disaster," said a person familiar with the fund's moves.
These days, it seems everyone is beating up on hedge funds, including investment newsletters. And with good reason. As smart money continues to fall off a cliff, closing their funds, hedge funds have finally seen the light, turning bullish on the global economy:
Hedge fund managers have become more positive about the global economy, with optimists outnumbering pessimists three to one.About time hedge funds stopped focusing on Grexit, the 'imminent' collapse of eurozone, the hard landing in China and the US fiscal cliff.
However, the "bulls" versus "bears" data, compiled by industry research firm Aksia, also showed increasing fears that a credit bubble is emerging.
Almost 32pc of managers warned that debt was the next bubble risk. Askia surveyed 168 separate hedge fund managers with assets of $900bn (£560bn) between them.
Although many still predict a Greek exit from the euro or a Spanish or Italian bond default, overall attitudes are more positive, with managers “bullish on financial assets, comfortable with the stability of the markets... and less sensitive to the impact of macro/political risks”.
One fear last year was a large scale sell-off of bank assets. However, the survey showed that ECB lending had given banks access to financing, “allowing them to avoid forced sales of assets at bargain prices”.
By the way, the biggest risk going forward is a fiscal cliff melt-up. I remain long coal, steel, copper, energy, tech, financials and Chinese shares (FXI). Watching stock market every day (my obsession), I'm seeing junk rallying hard, which tells me the animal spirits are alive and well.
On that note, leave you with 13 insights from Paul Tudor Jones, one the many top hedge fund managers I track closely every quarter (h/t, Market Folly):
PTJ is not only a successful hedge fund manager and philanthropist, but also very original and clear thinker. Here are some of his best market-related insights:No doubt about it, the very best money is made when the market turns. But in a low interest environment, the market will turn several times, so choose your spots carefully. And while you should let your winners run, don't be afraid to take money off the table after a nice ride up.
1. Markets have consistently experienced “100-year events” every five years. While I spend a significant amount of my time on analytics and collecting fundamental information, at the end of the day, I am a slave to the tape and proud of it.
2. I see the younger generation hampered by the need to understand and rationalize why something should go up or down. Usually, by the time that becomes self-evident, the move is already over.
3. When I got into the business, there was so little information on fundamentals, and what little information one could get was largely imperfect. We learned just to go with the chart. Why work when Mr. Market can do it for you?
4. These days, there are many more deep intellectuals in the business, and that, coupled with the explosion of information on the Internet, creates an illusion that there is an explanation for everything and that the primary task is simply to find that explanation. As a result, technical analysis is at the bottom of the study list for many of the younger generation, particularly since the skill often requires them to close their eyes and trust price action. The pain of gain is just too overwhelming to bear.
5. There is no training — classroom or otherwise — that can prepare for trading the last third of a move, whether it’s the end of a bull market or the end of a bear market. There’s typically no logic to it; irrationality reigns supreme, and no class can teach what to do during that brief, volatile reign. The only way to learn how to trade during that last, exquisite third of a move is to do it, or, more precisely, live it.
6. Fundamentals might be good for the first third or first 50 or 60 percent of a move, but the last third of a great bull market is typically a blow-off, whereas the mania runs wild and prices go parabolic.
7. That cotton trade was almost the deal breaker for me. It was at that point that I said, ‘Mr. Stupid, why risk everything on one trade? Why not make your life a pursuit of happiness rather than pain?’
8. If I have positions going against me, I get right out; if they are going for me, I keep them… Risk control is the most important thing in trading. If you have a losing position that is making you uncomfortable, the solution is very simple: Get out, because you can always get back in.
9. Losers average down losers
10. The concept of paying one-hundred-and-something times earnings for any company for me is just anathema. Having said that, at the end of the day, your job is to buy what goes up and to sell what goes down so really who gives a damn about PE’s?
11. The normal progression of most traders that I’ve seen is that the older they get something happens. Sometimes they get more successful and therefore they take less risk. That’s something that as a company we literally sit and work with. That’s certainly something that I’ve had to come to grips with in particular over the past 12 to 18 months. You have to actively manage against your natural tendency to become more conservative. You do that because all of a sudden you become successful and don’t want to lose what you have and/or in my case you get married and have children and naturally, consciously or subconsciously, you become more conservative.
12. I look for opportunities with tremendously skewed reward-risk opportunities. Don’t ever let them get into your pocket – that means there’s no reason to leverage substantially. There’s no reason to take substantial amounts of financial risk ever, because you should always be able to find something where you can skew the reward risk relationship so greatly in your favor that you can take a variety of small investments with great reward risk opportunities that should give you minimum draw down pain and maximum upside opportunities.
13. I believe the very best money is made at the market turns. Everyone says you get killed trying to pick tops and bottoms and you make all your money by playing the trend in the middle. Well for twelve years I have been missing the meat in the middle but I have made a lot of money at tops and bottoms.
Below, Wells Fargo Global Fund Services Co-Head Chris Kundro discusses the hedge fund outlook for 2013. He speaks with Betty Liu on Bloomberg Television's "In the Loop," saying hedge funds are seeing more closures.
And SkyBridge Capital Portfolio Manager Troy Gayeski discusses the performance of hedge funds and his investment strategy. He also speaks on Bloomberg Television's "In The Loop." Listen to what he says on fees.
Finally, Bruce Springsteen performs his classic hit "Born to Run" along with the E-Street band and special guest Jon Bon Jovi live at at Madison Square Garden during the 12/12/12 Sandy Relief concert. Before the show began, $30 million had been raised from ticket sales and sponsors, with all proceeds donated to the Robin Hood Foundation, a foundation which was the brainchild of Paul Tudor Jones.
While institutions are doling out millions in fees to hedge fund and private equity, and many of you are spending money on Christmas gifts, this is a good time to remind everyone to donate to those less fortunate. Also, please show your appreciation and support this blog. I put a lot of time and effort to provide you daily comments, so please show your appreciation via a donation or subscription (top right-hand side). Thank you and have a great weekend.