How Brexit and Covid-19 combined to hit UK hedge funds
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In early 2016 billionaire scientist David Harding opened a San Francisco office for his booming London hedge fund Winton Group. It was seen as a bold step by the firm — which at the time managed $34bn in client assets — to move into the world’s technology heartland. The company, competing with US tech giants such as Google and Facebook for talented staff, was hoping to tap into the Bay Area’s huge pool of coders and innovation.
The move was symbolic of the UK firm’s global ambitions following phenomenal growth in the years after the credit crisis but also of the strength of the industry in London, with many of the star performers based in the upmarket Mayfair district. In 2015, six out of the world’s 10 biggest hedge funds were listed as basing their money management wholly or jointly out of the UK. Winton was 10th largest on the HFM Global Billion Dollar Club list.
Five years later, that number has shrunk to three. Winton has closed its California operation and reduced its presence in New York. Poor performance, particularly during the coronavirus pandemic, and a controversial decision by Mr Harding to move away from a style of investing he pioneered in the 1980s have weighed on the firm, whose assets have recently tumbled to around $12bn. Staff numbers have been cut. And at the start of this year Winton ranked 23rd and is likely to have fallen further after recent losses.
It is not alone. A number of London’s biggest hedge fund firms, including CQS and Lansdowne Partners, have suffered big losses this year. Dissatisfaction with lacklustre performance in the $3.2tn industry — which uses bets on rising and falling prices across markets and which once seemed to offer the promise of profits in any environment — has led to more than $120bn of client outflows globally since the start of 2018, according to data group HFR. Investor interest has moved on from hedge funds to fast-growing US technology stocks and the private equity and debt sectors.
As growth in the once-booming industry has stalled, London has looked exposed. New York, Connecticut and the wider North American hedge fund sector have been better able to withstand the downturn than managers in the UK, holding on to assets and delivering higher returns.
The share of global hedge fund assets run by UK-based managers has shrunk from 14.9 per cent at the end of 2015 to 12.6 per cent at the start of the coronavirus crisis, according to HFR. The US’s share dipped slightly, from 77.2 per cent to 76.9 per cent, with Canada and France both picking up new business. US-based managers made an average return of 56 per cent between January 2012 and July 2020, according to investment firm Aurum Fund Management, while UK-based managers made 40 per cent.
“The best firms by and large are in New York and always have been,” says Winton’s Mr Harding. “The UK is slightly little brother to the US.”
Now the disproportionate impact of the coronavirus crisis on the London sector, which employs thousands, and uncertainty over the future trading relationship with the EU threaten to further damage the UK capital’s prospects, say industry observers. Once the Brexit transition period comes to an end in December, UK firms could lose some marketing privileges to EU-based clients and could eventually also face tougher rules if they want to run EU-based funds.
“The US dominates the hedge fund industry. It’s been trending in that direction for quite some time,” says Troy Gayeski, co-chief investment officer at New York-based SkyBridge Capital, which invests in hedge funds. “This has only been amplified by the pandemic. The US has the growth engines.”
Primary among those is the US stock market, which is more likely to be traded by US-based hedge fund managers than their European rivals, and has dramatically outpaced European indices this year, continuing a long-running trend. The S&P 500 index has soared to record highs this summer and despite recent falls is still up 3.4 per cent this year, while the Nasdaq has climbed 21 per cent. In contrast, the Stoxx Europe 600 is down 6.4 per cent and the FTSE 100 is down 20.2 per cent, in dollar terms.
Some of the hedge fund winners through this year’s market turmoil have been huge funds headquartered in the US, albeit with some London operations. While US managers such as Bridgewater Associates and Renaissance have not been immune from market falls, Elliott Management, Millennium Management and Citadel are among those to have come through the crisis largely unscathed and made money by cutting risk levels, and profiting from market dislocations, according to investors.
Travel restrictions during the pandemic are not helping UK managers either. Since the discovery of Bernard Madoff’s massive Ponzi scheme in 2008, many investors have insisted upon meeting their money managers face to face and doing extensive on-site due diligence before investing. Now, with coronavirus making that harder, coupled with better performance from US managers, some big American institutions are preferring to invest with easier-to-access domestic firms and are eschewing European funds.
“There’s just so much [investor] capital in the US,” which benefits the US hedge fund managers on their doorstep, says one London-based executive who has recently left the industry and moved into the tech sector in pursuit of better growth and profitability. “Whatever Japanese and European investors have just pales into comparison with the US.”
Deadlock in the talks over the shape of the UK’s future trading relationship with the EU threatens to further damage the industry, say legal experts. As it stands, from next year UK-based managers face barriers marketing some fund management services to EU-based clients.
A critical issue for the London industry is the system of “delegation” — the extent to which an EU-based firm can delegate the management of a fund to a UK-based manager. Such arrangements are lucrative for many London managers, who use firms in countries such as Luxembourg or Ireland with little in the way of traders or risk managers to delegate back to the UK, where the fund managers sit. However, the European Securities and Markets Authority, the EU regulator, in August wrote to the European Commission to recommend a tightening of the rules, which could mean UK firms having to move more investment professionals to mainland Europe.
“We are at a crunch point,” says Leonard Ng, a partner at law firm Sidley Austin, who advises on UK and EU regulatory issues. “This will be a period of stress for the asset management industry.
“Delegation . . . is about moving the centre of activity away from the UK into the EU,” adds Mr Ng, who predicts a “splintering” around Europe of the expertise that is currently centred in London. A dilution of that expertise in London threatens jobs and tax revenues in the UK.
While some high-profile executives in the UK industry — including Crispin Odey and Paul Marshall — backed an exit from the bloc, others are now looking at what it means for their business and whether they need to relocate.
London-based H2O Asset Management, which manages €21.7bn in assets and which was co-founded by former Crédit Agricole star fund manager Bruno Crastes, opened an office in Paris last year as a hedge against Brexit and is considering relocating fund managers there, says a person familiar with the firm. Mr Crastes changed his residency from the UK to Monaco in 2017, the year after the UK’s Brexit referendum vote, according to regulatory filings.
Last year former GLG star trader Greg Coffey, one of Europe’s best-known hedge fund managers, moved his hedge fund firm Kirkoswald Capital to New York over concerns about London’s role as a financial centre.
While few believe London will cease to be a hub for hedge funds, an ebbing away of the industry puts further pressure on its place in global finance. As recently as March 2018, London was ranked as the world’s top financial centre, according to Z/Yen’s Global Financial Centres index. It has subsequently slipped into second place, behind New York. And in the consultancy’s most recent survey, in March, London suffered the second-biggest fall of any of its top 40 rivals in the score used to determine its ranking. It now sits only marginally above third-placed Tokyo.
“Brexit has hurt [hedge fund managers]. A lot are French or Italian,” says one former London-based manager now located in continental Europe. “That’s scared them, they don’t feel they’re welcome.”
A ‘golden age’
The upmarket London district of Mayfair — once an area of muddy fields before King James II gave permission in 1686 for an annual fair to take place in May — has long been synonymous with the UK hedge fund industry. Traders relocated from the City of London in the 1990s and early 2000s to be near the area’s private banks and their ultra-wealthy clients, exchanging trading ideas and gossip in trendy hang-outs such as The Wolseley on Piccadilly and The Arts Club on Dover Street.
The arrival of high finance, an influx of ultra-luxury retail boutiques and soaring office rents changed the character of the neighbourhood. Funds such as Lansdowne Partners, based just off Berkeley Square, and GLG Partners, which paid then-record rents for space on Curzon Street, grew to be among the global industry’s biggest names.
That growth was helped by the introduction of the euro in 1999, which provided arbitrage opportunities that funds could trade, and a wealth of tech stocks to bet against in the dotcom bubble of the opening years of the 2000s.
“When the euro came in, hedge funds absolutely nailed it [the trading opportunity],” says Rick Sopher, chief executive of investment firm Edmond de Rothschild Capital Holdings. “It was the golden age of European hedge funds.”
But many of the trading opportunities that made European traders rich have since shifted to the other side of the Atlantic, particularly as the US tech sector has grown. “[European hedge funds] had to look for growth companies, and the companies on their doorstep were not growing that much,” adds Mr Sopher.
Some who know Mayfair and its hedge fund occupants well see signs of change. Laurence Davis, owner of Mayfair institution Sautter Cigars on Mount Street expects more of his loyal hedge fund customers to move out of the UK. He has already seen some managers leave, he says, but not yet “in the huge numbers that might happen. We haven’t felt Brexit in terms of hedge funds in central London [yet]”.
While the impact on the ground is clouded by the effects of coronavirus and the growth of sectors such as private equity, the fortunes of a number of big-name firms have waned.
Lansdowne Partners was once seen as the gold standard in equity investing. But it wrote to investors at the start of the year to describe a “disappointing” 2019 in which its main fund had made just over 1 per cent while equity markets had soared, according to a letter seen by the Financial Times. The investment group has been further caught out this year, by large bets on airline stocks and on a recovery in the UK. During the summer, it shut its flagship hedge fund, which is down 22 per cent this year.
Close by on Trafalgar Square, Michael Hintze’s CQS, known as one of Europe’s best credit traders, was caught out in this year’s market slump. A fund that he personally manages, which had one of the sector’s best records including gains of more than 30 per cent in 2012 and 2016, lost around $1.4bn in the market turmoil, thanks largely to bad bets on structured credit.
Firms such as GLG, now part of Man Group, GAM and Odey have also faced their own struggles since their heydays. The value of GLG has been written down by more than $1bn since it was bought by Man, GAM suffered a scandal involving a star fund manager that cost it billions of euros in assets, while Odey's assets have also fallen.
Winton’s Mr Harding says the performance of his fund, which is down around 17 per cent this year, has been “very, very disappointing”. However, he adds that does not mean the fund is broken and he does not regret his decision to change trading strategy away from trend-following. “I’m quietly confident in the longer term,” he adds.
Not all London funds are struggling. Man Group manages $108bn and has relocated GLG’s traders from Mayfair to the City of London. While Marshall Wace, based a short distance from Mayfair near Sloane Square, has $45bn in assets. Both have grown strongly in recent years.
Yet some in the sector see the London industry’s struggles as part of wider problems.
“At one point London had a real shot at potentially surpassing New York as the financial hub of the world,” says Mr Gayeski. “But the eurozone crisis and Brexit [changed that].”
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