Being a billionaire hedge fund manager is not as much fun as it used to be. The 1990s, so legend has it, were a golden era for the humble hedge fund manager, who could set up a company with just a computer and a telephone, without facing the glare of regulators, the media or the public.
But the days of 21-year-old whizz-kids founding wildly successful investment businesses from their university dorm rooms or their parents’ garages are over. Today, the sector has been reined in by a swath of new rules in the US and Europe designed to clip the buccaneering habits exhibited by some industry figures in their heyday.
Rather than face the pressures of the new world of investing a handful of hedge fund managers have turned their backs on running money for external investors altogether.
Two of the best known are George Soros, the 85-year-old investor and philanthropist worth an estimated $23bn, and Steven Cohen, the controversial financier who was forced to wind down his hedge fund, SAC Capital, after the company pleaded guilty to insider-trading charges in 2013.
The backgrounds of Soros, a Hungarian-born liberal who made a fortune by betting against the Bank of England during the Black Wednesday currency crisis of 1992, and Cohen, a New York native and poker enthusiast whose company was fined a record $1.8bn by US authorities, are worlds apart.
Yet the pair are united in their decision to transform their companies into family offices, which are exempt from most of the new rules in the US and Europe.
Soros closed his Quantum Endowment Fund to non-family members in 2011 to avoid unwanted regulatory scrutiny under the Dodd-Frank financial reforms, which aimed to improve investor protection but also raised compliance and reporting costs for hedge fund managers.
Cohen’s SAC Capital made the same transition last year to become Point72 Asset Management, an entity focused on managing the 59-year-old’s $10bn fortune, albeit for very different reasons. As part of his company’s guilty plea, Cohen agreed his firm would no longer manage money for outside investors.
The consensus among investment professionals is that more hedge fund veterans will follow this path as the industry continues to shed its Wild West reputation and the burden of running large amounts of external money intensifies.
“Those hedge fund industry founding fathers that remain active in it may barely recognise today’s $3tn industry compared with its form in the past,” says David Walker, head of European institutional research at Cerulli Associates, the asset management research group. “Onshore regulation, plus public reporting of significant short positions, are worlds removed from the barely regulated industry they once knew. Those managers that grew up in a less restrictive regulatory landscape may yearn for its freedoms.”
When a hedge fund becomes a family office, all funds are returned to outside investors and the new entity runs the money of the manager and his or her family members alone. Family offices do not need to be registered with the US Securities and Exchange Commission as an investment adviser and therefore are not subject to its regulation and disclosure requirements.
There are provisions in the SEC rules by which key employees may invest alongside the family and thereby participate in the investment results, but non-family members may not have direct equity participation in the business, according to Marv Pollack, managing director of the Family Office Exchange, a network that provides advice to wealthy individuals.
Other changes that have proved unpopular with many in the industry include pay restrictions for managers active in the European market under the Alternative Investment Fund Managers Directive (AIFMD), which came into force in 2011. The new rules also include restrictions on how leverage can be applied and contain onerous reporting obligations.
Troy Gayeski, partner at SkyBridge, the New York-based fund of hedge funds company, believes more family office conversions are imminent as hedge fund executives who have amassed large amounts of money tire of the new regime. “Ten years ago a hedge fund with $50m of assets could generate plenty of revenue to cover overheads. These days it has to be $500m, and part of the reason is that regulatory requirements have gone up dramatically,” he says.
Covepoint Capital, a New York-based hedge fund set up by former Bear Stearns employee Melissa Ko in 2008, is just one example of a large hedge fund that succumbed to this desire for greater freedom. The company returned all outside money to investors and converted the business to a family office in 2013. Greg Williams, business controller at Covepoint, which at its peak handled more than $1bn of assets, told the FT at the time that the changes were in response to “regulatory requirements [that] have become much more burdensome”, adding: “The family-office structure allows for the flexibility that we are seeking at this time.”
In May, JAT, the $1.7bn hedge fund known for its large stakes in companies such as Twitter, Yahoo and the Madison Square Garden company, joined the list of groups that will be returning money to outside investors and becoming a family office. John Thaler, who founded the company in 2007, had encountered performance difficulties, including an 11.3 per cent loss last year, according to the Wall Street Journal. In a letter to investors, however, he attributed the decision to wanting to spend more time with his “young family”.
More hedge fund luminaries are expected to bring the shutters down on external investors, as a growing number of alternative funds struggle to produce decent returns. The average hedge fund returned 3.3 per cent in 2014, compared with 5.5 per cent for the MSCI World index.
“Hedge fund managers are rational entities who understand what a challenging environment this is,” Gayeski says. “For some, it’s not worth the effort to grind out what they view as less than thorough returns.”
Perhaps more disturbingly for other hedge fund veterans, however, their business is no longer as revered as it used to be. It has become almost routine for politicians in the developed world to attack the hedge fund industry in the run-up to elections.
Such moves are seen widely in the industry as insincere and calculated, designed to score points with an electorate that has become disillusioned with the world of finance in the aftermath of the financial crisis.
In Germany, Franz Müntefering, former chairman of the Social Democratic Party, branded hedge funds “locusts” in 2005. The term has stuck.
Even Donald Trump, the Republican property magnate running for president of the US, has lashed out at hedge fund managers, branding them “paper-pushers” who do not pay their fair share of tax. In an interview with CBS television in August, the 69-year-old said of the hedge fund elite: “They are energetic. They are very smart. But a lot of them — they are paper-pushers. They make a fortune. They pay no tax. It’s ridiculous.
“The hedge fund guys didn’t build this country. These are guys that shift paper around and they get lucky. Some of them are friends of mine, some of them I couldn’t care less about. These guys are getting away with murder.”
But while hedge funds — and their managers — do indeed pay tax, within this hostile political and regulatory environment it is little surprise that managers who have already made their fortunes have begun to question the appeal of managing outside investors’ money.
“The hedge fund industry may still have a glamour appeal compared with other sectors, but we are a long way from where we were in 2006 or 2007 when everyone wanted to quit the sell-side [investment banks] and join a hedge fund,” says Gayeski.
The investment moguls at the head of some of the recently established family offices may not escape the long arm of international regulators for much longer, however. Barbara Wall, director at Cerulli, says: “I would expect to see more conversions but I don’t expect this to be a huge trend. Family offices are on the radar of the SEC, and Europe will also be turning its attention to these quiet but powerful entities.
“Single family offices manage significant sums and their actions have a major impact on global capital flows. It’s only a matter of time.”
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