Lincoln Center, home of the Metropolitan Opera and the New York Philharmonic, exchanged art for avarice this week. Taking the stage of Avery Fisher Hall, where Leonard Bernstein used to conduct, was a very select group of performers: the billionaire virtuosos of the hedge fund world.
Gathered there were investors who had made big money by making bold calls. Some had made money by taking on governments: Stanley Druckenmiller made a fortune helping George Soros drive sterling out of the European exchange rate mechanism, while Paul Singer, founder of Elliott Management, last year attempted to repossess an Argentine naval vessel to settle a debt.
There were also corporate agitators with ambitious ideas. David Einhorn of Greenlight Capital has spent this year fighting Apple over its cash pile. Bill Ackman of Pershing Square wants to shake up Procter & Gamble, the US consumer goods group.
The investors were there to promote their latest big ideas and perhaps move markets in their favour, to gain some good publicity and to benefit a good cause.
Each man – there were no women – pitched an investment idea from their portfolio to a sold-out crowd of investors, all for a charity set up to honour the late Ira Sohn, a financial analyst who died of cancer at 29. But they also came to get the next big idea, that elusive concept that will generate “alpha” – the hedge fund term for beating markets.
“The ideas, its always about the ideas,” says Chandresh Patel of CNP Advisors. “Alpha is everywhere, it’s the implementation that gets everybody.”
Good ideas are the fuel of the hedge fund industry, where performance is supposed to be so stellar that it justifies the high fees earned by the managers. Yet this week’s conference points to one of the central problems of the hedge fund world: there are many brilliant investors and great investment ideas. But as an industry they have not worked nearly so well as advertised.
True, some ideas pitched last year were brilliant. Larry Robbins of Glenview Capital picked a healthcare stock, Tenet, that is up 140 per cent since the 2012 event as fears that the Supreme Court would strike down President Barack Obama’s healthcare law proved unfounded.
There were also some big losers, though, and the gurus’ best ideas collectively failed to beat a passive index fund tracking the S&P 500, which produced a 22 per cent gain.
The performance of the wider hedge fund industry has been no better. Simply put, the average hedge fund tracked by Hedge Fund Research has failed to beat the US stock market four years in a row.
“There has been a crisis of confidence with investors in hedge funds, and a lot of investors have come to question if hedge funds have a place in their portfolios at all – or if they do have a place, what it is for,” says Robert Frey, a former senior executive at Renaissance Technologies, perhaps the industry’s most successful hedge fund manager ever.
Renaissance has produced returns of 35 per cent, on average, in its flagship Medallion fund every year since its foundation in 1989 – staggering figures that are net of the maths-oriented firm’s even more eye-watering fees: a 44 per cent cut of profits and 5 per cent of all assets annually. But Medallion’s returns were truly unattainable, since the fund closed to new money in the 1990s.
Meanwhile, as investors ponder the merits of hedge fund investments, the rest of the industry is showing signs of well-heeled distress. The top 25 investors earned $15bn between them last year, according to Institutional Investor’s Alpha website, a reasonable haul but the lowest total since 2008.
London’s Ark gala, a lavish spectacle of charity excess that at its peak in 2007 raised £26.6m when Madonna and Prince serenaded guests, has been quietly mothballed.
Yet there is hope. The mood has begun to turn as stock markets have rallied this year, bringing most hedge fund managers above, or at least close to their high-water marks, the point above which a hedge fund can start to charge a performance fee. “They are in a better place. It helps when you can see past that bar,” says Paul Germain, head of Prime Services for Credit Suisse.
This year’s tips from the Sohn conference included a short bet on Chipotle Mexican Grill (“a gourmet burrito is an oxymoron,” according to bond king Jeff Gundlach), and a long bet on Google, from Soros protégé Mr Druckenmiller.
With confidence comes a greater willingness to take risk, in itself producing more trading activity and opportunity. Some of that optimism was on show in Las Vegas this week, at another hedge fund conference where among the speakers was the actor Al Pacino, who shared tips with the hedge fund set on how to deal with prima donnas.
Ray Nolte, chief investment officer of SkyBridge, the alternative asset manager behind the conference, says the industry’s mood has shifted.
“It is upbeat, I think you feel that, there is a vibrancy, a lot of activity going on,” he says.
Part of that is the return of performance. The average hedge fund has gained 4.4 per cent for its investors so far this year after fees, according to HFR, the best start to the year since 2007.
They have been helped by the policies of Shinzo Abe, the Japanese prime minister. Japan has provided a clear winning trade for many hedge funds which bet that policies to revive economic growth would send the currency plummeting, and that in turn sent stocks soaring.
The Nikkei 225 is up 40 per cent this year, while the yen has fallen against the dollar. Hedge fund managers such as Kyle Bass of Hayman Capital, Mr Einhorn, Dan Loeb of Third Point, as well as Paul Tudor Jones, and Caxton Associates, have reaped big profits.
“We may be back in a world where macro managers can understand central banks’ policies and position with them profitably,” says Jim Vos, head of Aksia, a hedge fund advisory firm. “Central banks are doing different things now, and moving at different speeds. The macro managers just nailed Japan, hit it perfectly.”
Assets have begun to return to the industry as well, with $15bn in net new money in the first quarter. Equity trading funds are also starting to attract capital again as stock picking begins to return to form.
Yet the existential question remains about the purpose of a hedge fund. Mr Frey now runs his own fund of hedge funds, FQS, and he says “people used to believe that hedge funds were pure absolute return plays – that they would make money no matter whether markets were up or down. But frankly, that has never actually been true.”
Since 2008, the typical hedge fund client has changed significantly: risk-averse pension funds, endowments and insurance companies now dominate funds’ investor lists. Hedge funds that have wanted to recover their assets after 2008 have had to adapt to their new clients’ needs accordingly.
“The thing is, a lot of the big institutions that now invest in hedge funds don’t want huge returns. They want consistent returns. If you can grind out 10 per cent a year over and over, that’s all an institution wants,” said the head of one large endowment at an industry awards ceremony in London this week, held in a converted Mayfair church.
That 10 per cent return is something the industry has not managed to deliver so far, however. Compare the average hedge fund to a simple passive portfolio invested 60 per cent in stocks and 40 per cent in bonds over the past decade and they look the same: both gave an investor 7.3 per cent a year, on average.
Fees are the difference, however. Over the past five years investors have paid more in management fees than they have got in performance – just 9 per cent according to HFR. “What really astonishes me though, is why fees haven’t come down more,” said the endowment manager. “If you’re still charging 2 per cent a year, and only making 10, or less, that’s a problem.”
David Kabiller of asset manager AQR agrees, saying most hedge fund managers do not perform well enough to justify the “two and 20” fee arrangement, where they are paid a flat 2 per cent of total asset value as a fee, plus 20 per cent of any profits. “I don’t think the industry as a whole deserves two and 20,” he says. But “there are certainly individual managers who do”.
There are cold hard numbers, and then there is theatre. The industry pitch is not about the chorus, but the breathtaking soloist. The Lincoln Center billionaires are investors, but they are also showmen. So their grave warnings about a coming crash in China, or the precarious value of sovereign debt are calibrated to enhance perceptions of their investing skill.
“One thing that I learnt very clearly in 1999 was that hedge fund managers always have a bias to talk doom and gloom, because if you then make money, investors think you did it whilst taking little risk. Whereas if you talked optimistic, investors think you just rode the market upwards,” says Mr Vos.
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