Transcript: Hedge fund pioneers face signs of a reckoning

This is an audio transcript of the Behind the Money podcast episode: ‘Hedge fund pioneers face signs of a reckoning’

Michela Tindera
Hey there. It’s Michela. I have a short note before we get started. Later this year, Behind the Money will be teaming up with our friends over at the FT’s Unhedged podcast for a special episode featuring you. If you have a question about markets, finance or economics, send it in and we might answer it on the show. To get in touch, you can reach out to me directly. My email and contact details are in the show notes. I’m excited to see what you send in. So with that, let’s jump into this week’s episode.

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A little over a year ago, a hedge fund executive named Bobby Jain was feeling stuck. For years, Jain had climbed his way up through finance. The FT’s Ortenca Aliaj tells me that he worked at Credit Suisse, then spent a while at one of the world’s most successful hedge funds, Millennium Management. 

Ortenca Aliaj
Jain is a very well-known person in the hedge fund industry. From all of the accounts we’ve heard of him, he’s well liked. You know, a lot of people talk about the fact that he’s quite charismatic. 

Michela Tindera
But by the end of 2022, the FT’s Harriet Agnew tells me that he needed a change. 

Harriet Agnew
He realised that his career at Millennium had hit a bit of a ceiling, so he decided to leave. Then last summer he set up his own firm, which is called Jain Global. 

Michela Tindera
Jain’s plan was to start a specific kind of hedge fund. It’s known as a multi-manager fund, and it makes sense that Jain would go for this option. For one, he had experience. Millennium was also one of these multi-managers. But beyond that, in recent years this type of fund has been taking off. 

Harriet Agnew
Multi-manager hedge funds have been the fastest-growing and most profitable corner of the 4tn global hedge fund industry in recent years. Goldman Sachs estimates that between 2018 and 2022, multi-manager assets grew by 150 per cent and the rest of the hedge fund industry grew by just 13 per cent. 

Michela Tindera
So here you have this well-known executive ready to do the next big thing in a sector that’s pretty much in a golden era. 

Harriet Agnew
When news reaches the market that Bobby Jain is setting up Jain Global, there’s a big amount of excitement around it. And early on, people are saying this could be the biggest hedge fund launch ever. 

Michela Tindera
To get a hedge fund off the ground, of course, you have to raise money from investors, and Jain’s goal for this was sizeable. 

Harriet Agnew
He set a fundraising target of between 8 and $10bn. 

Michela Tindera
But last month, roughly half a year after Jain started setting up his firm, the FT reported that things weren’t going exactly according to his plans. 

Harriet Agnew
In January, we revealed that Bobby Jain’s original fundraising target was falling short and that he was now looking to launch with 5 or 6bn, maybe even less. And he’s also sweetening the terms for investors who sign up fast, including offering things like performance fee discounts to try and lure people on board. 

Michela Tindera
Now Ortenca and Harriet tell me that what Jain’s fund is experiencing is an example of something bigger that’s starting to happen within the sector. Performance among these multi-manager hedge funds has been slowing down and it could spell the end for these boom times. 

Harriet Agnew
I think we’re starting to see signs of a reckoning and a few cracks start to appear. (Cracking sound)

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Michela Tindera
I’m Michela Tindera from the Financial Times. Today on Behind the Money, we’re looking at whether some of the best-performing hedge funds of all time might just be victims of their own success.

Hi, Harriet, Ortenca. Welcome. 

Harriet Agnew
Thank you. 

Ortenca Aliaj
Hello. Thanks for having me. 

Michela Tindera
To understand what’s happening with Bobby Jain’s fund, I think we first need to understand more about what a multi-manager hedge fund really is. And so to do that, I think we have to go back to the industry’s origins. So tell me more about that. 

Ortenca Aliaj
Well when the industry first broke out in the ‘70s and ‘80s, it was really dominated by these big personalities like George Soros, Julian Robertson, Jim Simons. 

Harriet Agnew
And they made their profits and their reputations by taking big thematic bets on markets. This was everything from equities, bonds, currencies, commodities. 

Michela Tindera
So big personalities and big bets. But by the early 1990s, two new players emerged — Ken Griffin and his firm Citadel, and Izzy Englander and his firm Millennium. Now, they ultimately pursue strategies that are quite different from their predecessors. They pursue what’s known as a multi-manager hedge fund strategy. 

Ortenca Aliaj
So a multi-manager hedge fund is . . . there’s another name for it which is a pod shop. 

Michela Tindera
And what does that mean?

Ortenca Aliaj
I guess the best way to describe it was, if you turned a multi-manager hedge fund inside out, they could be a host of individual hedge funds. So you could have a commodities hedge fund, a long/short equity hedge fund, a fixed income hedge fund. They could specialise in these various areas. But then if you turn it back in on itself, it sits under the multi-manager fund strategy. 

Michela Tindera
So like the name says, there are multiple investing strategies that are managed inside these types of hedge funds. And their massive returns have made them really popular. 

Harriet Agnew
The pitch that the multi-managers make is that they’re very well diversified and that they will try and make money whichever way the market swings. 

Ortenca Aliaj
And so in years where you’ve had the S&P go down 20 per cent, you’ve had the multi-manager funds actually be up 15 or 10 per cent, in double digits. 

Michela Tindera
That sort of success is hard to deny. And so it’s no surprise that institutional investors like pension funds, endowments and the like, they’ve all been chomping at the bit to get in on this. And recently these firms like Griffin’s Citadel and Englander’s Millennium have been knocking it out of the park. 

Harriet Agnew
In 2022, Citadel became the best-performing hedge fund of all time, so it made a record 16bn in profits that year thanks to a big bet on commodities. 

Michela Tindera
Citadel and Millennium in particular have become so popular that actually in recent years they’ve had to close their funds to new investors, meaning that anyone else who wants to get in on this outperforming-the-market strategy has had to turn to other smaller multi-manager funds. 

Harriet Agnew
You have this scarcity of supply dynamic. So then you have clients clamouring to get into this very popular hedge fund strategy but finding that arguably the two best managers are closed to new money. So they then put money with other names and so that benefited the sort of next rung down of managers. 

Michela Tindera
Now the thing is, generating these kinds of returns doesn’t come cheap. Firms like Citadel and Millennium have to spend heavily on things like technology and data systems so they can keep an edge over their rivals, and they need to be able to pay top dollar for the sometimes hundreds of traders working for them who have highly specialised investing skills. And these heavy costs actually get passed on to the investor. 

Ortenca Aliaj
And the way that this is justified is that, hey, to be the best of the best, we need to hire the best talent, we need to have the best data system. And so we can give you 15 per cent return rate a year. But in order for that, you need to pay 30 or 35 per cent fees. And the way that they do that is they will basically charge the end investor, who can be the pension fund, the endowment, whoever that is, the fees for everything from Bloomberg terminals to client entertainment, to bonuses, certainly salary. And so all of these hedge fund expenses are going to the end investor, which is not the case for a, quote unquote, traditional hedge fund. 

Michela Tindera
But these sorts of costs for the multi-manager funds, for the investors, well, Harriet and Ortenca tell me that they’re creating sort of an unhealthy cycle that in some cases might just be this type of fund’s undoing. (Cracking sound)

More on that after the break. 

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Michela Tindera
So for these multi-manager hedge funds, the returns are high but so are the costs. And this has created a cycle that might spell trouble for these sorts of firms. So let’s begin there. OK. Ortenca, Harriet, as we talked about, multi-manager firms employ loads more people than your traditional hedge fund. And not only do they have more people, but each fund is competing to have the best, most talented traders on their staffs. So how is this impacting these firms? 

Ortenca Aliaj
You have this huge talent war going on where you’re having to pay increasingly larger sums to retain or to hire new fund managers. 

Harriet Agnew
Firms are paying sign-on packages of tens of millions. They’re paying these guaranteed payouts that can also stretch into tens of millions of dollars. So all of these, like, really expensive things that are just sort of adding to this massive cost base. Now, as we talked about, these costs are passed on to investors, but it means that the returns have to be higher in order to deliver a strong performance net of all fees. 

Michela Tindera
OK. So there’s that cycle we were talking about — paying for more talent, it increases costs, so then you have to perform better in order to make up for that spending. 

Ortenca Aliaj
Well, what happens is that if your investors are saying, hey, actually, I’m not OK with these fees, like, this is a lot of money, they can withdraw. 

Harriet Agnew
So if you find yourself in a situation where the amount of money a firm manages declines, the costs don’t fall in line with the decrease because it’s hard for managers to uncut spending at the same pace the assets are falling. So this means because the costs are shared among investors, you’ve got fewer investors ending up footing a larger bill that eats into returns, which then might trigger more cash being pulled out. So if firms go through a period of poor performance, they’re very vulnerable to this, a sort of downward spiral of redemptions, because no investor wants to be the last one left carrying the bag. 

Michela Tindera
Yeah, I can see how that could get out of hand. But there are actually two more big risks to these firms, even beyond this cycle. And the next one I want to talk about is what’s known as crowding the market. So what does that mean here? And what are you seeing? 

Ortenca Aliaj
So when we talk about crowding, we are talking about hedge funds that go into the same trade. And as we’ve discussed with multi-manager firms, some of them have grown to be so big that it’s almost inevitable that they have to invest in the same things. So Citadel and Millennium manage around the same amount of money, about $60bn. And when you add to that leverage, which is effectively these firms borrow money to put on trades, it can cause a pretty severe effect if something goes wrong in the market. And if something goes wrong for one of these firms where you have to unwind that bet or you have to sell out of it, it can very quickly cause problems and create this domino effect where everyone starts selling at the same time. And that can create huge losses. 

Michela Tindera
And what would be an example of that? 

Ortenca Aliaj
I think we saw an example of that in March 2020 with this trade that a lot of hedge funds were in, and is seen as a pretty safe bet. So really the return on that tends to be very small. But if it goes wrong, the firms use so much leverage, so much borrowed money to boost the returns within this trade that when it did go wrong in March 2020, the Federal Reserve had to step in. 

Michela Tindera
So basically, it comes down to the idea that even any kind of small cracks in these multi-manager hedge funds systems and the way that they operate, people should be watching them closely to understand what potential risks there are and how to fortify against them, I guess? 

Ortenca Aliaj
Yes that’s right. 

Michela Tindera
So the other risk area to talk about, which we often do, are higher interest rates. Harriet, how have those been impacting these funds? 

Harriet Agnew
You’ve got higher interest rates, which mean that cash is yielding 5 per cent and has emerged as a sort of viable place to put your money. And this means that investors are becoming much more demanding. It sort of raised the bar for what these managers need to deliver. 

Ortenca Aliaj
I don’t know if people will look at maybe putting money into a new hedge fund like Bobby Jain’s or even an existing smaller one and say, wait, why would I do that and lock up my capital for a year or two or five, when I can just invest in Treasuries and get a pretty decent return? And so justifying an investment in a hedge fund has become a harder task to do. And unless you’re really hitting it out of the park or doing really well, it’s hard to justify being in some of these firms. 

Michela Tindera
Sure. Yeah. I mean, it makes sense why Jain’s fund would be struggling to persuade investors to come on board if they could just invest in Treasuries. So how do you both see all this playing out? I mean, we’ve been in this golden era for these funds, but the stuff we’ve just talked about, you know, certainly seems like that’s primed to end. 

Harriet Agnew
There’s two potential scenarios here. There’s either someone goes out with a bang or the more prosaic reality of they just lose their edge. So I think if it’s the former, then leverage will come into play. So the multi-managers borrow a lot of money to magnify their positions, which magnifies their gains but will also amplify their losses if trades go wrong. The multi-managers will say that they’re very well managed and they’re highly diversified across strategies. So then maybe the greater threat is crowded trades that what was once lucrative becomes mainstream. And the profits from the moderate. 

Ortenca Aliaj
Well, yeah. If we talk about those three issues that we mentioned earlier — the interest rates, the talent war and the fact that there’s crowding — I think that gives a very good round-up of why someone like Bobby Jain might struggle, right, because he has no performance record. And so you’re telling investors to take a leap of faith, and you’re competing for talent with deeply entrenched rivals like Millennium and Citadel. So this confluence of factors makes it much harder. But look, I don’t think we should underestimate that however much he ends up raising, whether it’s 3bn or 4bn or 5, that’s not a bad thing. That’s still a lot of money. I mean, the ultimate question for Bobby Jain and every hedge fund is: how will he perform? Right? What is his record going to be like? Because that will ultimately determine who you can hire, how many investors go in, et cetera. So all he needs to do is really build this performance record, and he can do that with 2bn and 3bn, and 4bn. He doesn’t need 10bn to do that with. 

Harriet Agnew
And then the launch isn’t targeted until July. So there’s a lot that can happen between now and then. I definitely wouldn’t write him off. 

Michela Tindera
Yeah. And we’ll be watching. Harriet, Ortenca, thanks for being here. 

Harriet Agnew
No, thanks for having me. It was really fun. 

Ortenca Aliaj
Thank you for having me. 

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Michela Tindera
Behind the Money is hosted by me, Michela Tindera. Saffeya Ahmed is our producer. Topher Forhecz is our executive producer. Sound design and mixing by Sam Giovinco. Cheryl Brumley is the global head of audio. Thanks for listening. See you next week. 

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