Clients are increasingly willing to pay high fees — outsized even by hedge fund standards — to gain access to a whole universe of investments, from U.S. stocks and precious metals to Asian currencies, executed by scores of traders who can be easily replaced if they stumble.
It’s a stark contrast to the old business model: Launch a fund, name it after yourself, call the shots, profit. A generation of managers are finding this new style more appealing — and in some cases have little choice since flashy trading stars aren’t in vogue with investors any more. With a shakeout underway in an industry that runs about $4 trillion, multi-strats are the only way to grow.
The Great Migration
Behind their epic rise is consistent performance during periods of market chaos. Take two of the oldest and largest multi-strat houses in the world: Millennium Management and Citadel. They pool investor money into huge funds, before parceling it out in various trading strategies — all under one roof, with layers of risk management to avoid trading accidents.
A $1 million investment in Millennium’s multi-strategy pool at its launch in 1989 is worth about $67 million now. Citadel has turned a million dollars into about $236 million since its start in Nov. 1990. By contrast, $1m invested in the HFRI Fund Weighted Composite Index at the start of 1990, when the benchmark started, would be worth $18m.
Millennium has suffered one annual loss over three decades of trading, dropping 3% in 2008. Citadel has had two, falling by about 4% in 1994 and a whopping 55% in 2008, according to investor updates seen by Bloomberg. Meanwhile, more than 3,350 hedge funds have shut down in the past five years according to Hedge Fund Research Inc., some knocked out by market swings during the pandemic, highlighting how precarious single strategies can be.
Multi-manager platforms “have in effect become the most efficient allocators of capital,” said Caron Bastianpillai, who invests in a number of such funds at Switzerland-based NS Partners.
This dominance can crowd out new entrants. Abhijeet Gaikwad returned to Millennium, which runs $52 billion, this month after failed attempts to raise capital for his own fund. Industry veterans Colin Lancaster and Mitesh Parikh, who were on track to start their fund with $1 billion, last year took their business instead to multi-strategy firm Schonfeld Strategic Advisors. They’ve just been allocated $5 billion to run a macro trading unit.
Ryan Tolkin, chief investment officer of Schonfeld, said that for Lancaster, “in the eyes of both himself, as well as investors, he would be able to attract and recruit better talent by partnering with Schonfeld than trying to do it on his own.”
It’s also leading to takeovers, a true rarity in the world of hedge funds. Glen Point Capital, which amassed $3.8 billion and the support of legendary investor George Soros in its early days, abandoned its independence last month after clients pulled their money. Eisler Capital, a multi-strategy hedge fund, bought the business.
“Joining a multi-strat on Monday and having $500 million to punt around on Tuesday is a hell of lot more appealing than scrounging for $50 million of seed capital to start your own firm,” Andrew Beer, founder of New York-based Dynamic Beta Investments, said.
To be sure, other forms of fund still control most of the assets under management in hedge funds, at least for now. And talented individual traders can still do well, cashing in handsomely when their specialized trading tactic is in vogue. But picking top managers is a gamble in itself. Billionaire Chris Rokos’s record gains in 2020 were followed by his fund’s worst ever loss of 26% last year. Alphadyne, the New York-based hedge fund that had never lost money since its debut in 2006, finished last year down 21% after its bond market bets imploded.
Single-minded funds can also struggle with success, as growth spurts potentially make it more cumbersome to trade in the strategy that made their name. Any attempts to force change on a star trader could spook investors.
Multi-strats, meanwhile, have a low tolerance for underperformance. With individual managers less visible to clients, those who start losing in high single digits or overextend their risk can have their assets cut at best, and at worst can be fired on the spot.
This emphasis on rigor appeals to pension funds, foundations and endowments that have gravitated toward hedge funds, often without the resources to closely track what each manager’s doing. When the rest of the investment community opts for diversified multi-strats, why get on the rollercoaster with a rockstar?
The obvious downside is the price tag: expensive, but worth it, for the investors that continue to flock to these funds.
Clients at multi-strat funds typically sign up for high and opaque charges called “pass through”. Such charges can reach 10% or more on top of incentive fees, in sharp contrast with the standard hedge fund model of paying a 2% management fee and 20% of profit, with even these prices falling recently. The pass-through fee covers everything from boosting employee pay (and firing struggling traders) to covering office rent and even entertainment.
Some clients are also signing away their money for years. Millennium told investors in November that it had raised a record $10 billion for a fund that takes five years to exit fully. At least four other large multi-manager funds have changed their terms or started new share classes recently, all extending the time it takes for investors to get out.
“The idea that institutions willingly lock up their money for years then pay annual performance fees is the Frankenstein monster of incentive structures,” said Beer of Dynamic Beta, which tries to replicate hedge fund returns through cheaper strategies. “Imagine if VCs took profits when WeWork hit a $47 billion valuation.”
Too Big to Fail
Still, multi-manager funds are pretty much the only part of the hedge funds industry still attracting new money. Hedge funds collectively have drawn no new money since 2008, with all of their growth fueled exclusively by performance, according to a Bloomberg analysis of Hedge Fund Research Inc. data.
By contrast, a sample of twenty multi-manager funds collectively boosted assets by 510% to $222 billion over the past decade, data compiled by Julius Baer shows. Thirteen of them are now closed to new money.
These funds, of course, come with their own set of risks. While multi-strats are more cushioned than rivals against moves in one particular market, critics are worried about the concentration of assets, made worse by eager banks offering them enormous leverage to juice up their bets.
“Could you imagine the Fed allowing a $50 billion multi-strategy hedge fund to fail? I can’t. Think about the pain that Archegos caused and that was tiny in comparison,” said Will Potts, who is trying to start a multi-strategy fund by crowdsourcing investment ideas. “The damage that would be done to the prime brokers would cause financial distortions, it would be LTCM on speed.”
With echoes of the Long Term Capital Management rescue in 1998, the Federal Reserve pledged an unprecedented $5 trillion to keep markets running smoothly in March 2020 when an enormously leveraged bet called the Treasury basis trade froze — an intervention that veteran macro trader Paul Tudor Jones described as “a nuclear bomb.”
Sean McGould, who runs Lighthouse Investment Partners, isn’t concerned about a single event bringing down a multi-strategy fund, given their diffused risk-taking. He’s more worried about liquidity risk that may prevent leveraged hedge funds from turning bets. “If for some reason liquidity just dried up for a long period of time, and maybe that could be caused by interest rates rising or some other condition, it certainly makes it harder,” he said.
Over at Citadel, the biggest worry is making sure that the $43 billion firm remains in a position to respond to changes and keep attracting talent. “The key is maintaining Citadel’s culture of meritocracy, focus on talent and not becoming complacent so that whatever the risk — be it market, credit, liquidity or pandemic — our culture puts us in a position to adapt,” Zia Ahmed, a spokesman for Citadel said.
A spokesman for Millennium declined to comment.
For now, multi-strategy funds are continuing to lure talent and money at a furious pace.
Danilo Onorino is feeling the pain of their success. He founded Dogma Capital in 2014 after a brief stint with Millennium, where he found risk limits too stringent and required him to alter his trading style. “My strategy is not wild. I left because it was not a place for me,” he said. Onorino runs $10 million from Lugano in Switzerland and says raising capital is “almost mission impossible.”
It’s more of an opportunity for Richard Schimel, who launched Cinctive Capital Management in 2019 and has reviewed over 4,000 resumes, met with over 900 candidates and hired 53 traders. The equity-focused firm added risk arbitrage trading recently and plans to expand to macro and credit strategies, becoming home to scores of managers who’d rather not strike out on their own.
“You’re seeing a lot of those people who try and I give them credit for trying and hanging their shingle,” said Schimel. “In some cases, they’re going to get paid more being in a place like this than even starting their own businesses.”