Make no mistake, it’s been a tough year for the 2 and 20 crowd.
Between an inexorable slump in commodities (which has led directly to a burgeoning HY crisis), the volatility that comes with pervasive monetary policy confusion, a “surprise” China deval, tail risk galore, and a variety of spectacular blow ups (see Ackman and Valeant [11]), it’s become abundantly clear that when it comes to truth in advertising, hedge funds fail miserably as protecting against massive fat tail events apparently isn’t their cup of tea after all (see here for more [12]).
Even risk parity has suffered in an environment characterized by increasingly interdependent and correlated markets [13].
Well, now that pension funds [14] (and everyone else for that matter) have come to the realization that in a market backstopped by the central bank put, it makes a lot more sense to just buy the SPY for a fraction of a percentage point (in terms of expense ratios) than to pay 2 and 20 for someone to ride the beta train with the most leverage possible hoping that the Fed will prevent any events that actually need hedging, and now that HY is finally rolling over just like we said it would, the liquidations are multiplying.
"Funds depend on institutional investors such as insurers and pension schemes, who cannot afford to miss minimum return targets and are themselves under pressure from boards that oversee investments," FT writes [15].
“Most [fund] managers prefer to haggle like rug-salesmen at a bazaar; institutional investors would rather shop at Ikea,” says Simon Ruddick, founder of consultant Albourne and that means the trend shown in the following graph is likely to reverse going foward:
[16]
In a sign that things are getting progressively worse, “the number of funds liquidated climbed to 257 [in Q3], up from 200 in the previous three months,” Bloomberg notes [17], citing Hedge Fund Research Inc.
Total closures in the first nine months of the year hit 674, while AUM fell by $95 billion to $2.87 trillion during the quarter, “the most since the fourth quarter of 2008, when the industry lost $314.4 billion amid the global financial crisis.”
"The HFRI Fund Weighted Composite Index declined by more than 4 percent in the three months through September, its biggest quarterly drop in four years, as money managers were caught out by the devaluation of the Chinese yuan in August, which pummeled markets, and as oil and gold prices slumped," Bloomberg adds.
Now obviously - as noted above and as we documented extensively in the wake of the flash crashing madness that unfolded on August 24 - hedge funds are supposed to be a safe haven when market turmoil strikes but as it turns out, they aren't particularly adept at actually "hedging" and so, when the black swans come calling, the losses pile up.
So what's a "poor" hedgie to do? Well, cut fees for one thing. Here's FT again [15]:
Many hedge funds are cutting fees and negotiating with investors to trim some of their hefty costs and avert withdrawals after another mediocre year for returns.
The industry has been shifting for several years away from its traditional model of charging 2 per cent of assets and keeping 20 per cent of profit. Some funds are already wooing customers with fees closer to 1 per cent and 15 per cent, people in the industry say.
Management fees declined this year in every strategy except event driven, falling to a mean of 1.61 per cent from 1.69 per cent, according to JPMorgan’s Capital Introduction Group.
Several big-name funds have closed to outside investors or shut entirely this year: Michael Novogratz’s $2bn fund at Fortress Investment Group shut in October after having lost 17.5 per cent in 2015, and this month BlueCrest pushed out external investors, saying 2 and 20 was “no longer a particularly profitable business”.
Carlyle’s Claren Road, facing an exodus of half its clients after losses, delayed giving some money back, and offered reduced fees if investors agreed to stay with the fund for another two years, according to people familiar with the offer.
Glenview Capital manager Larry Robbins, whose fund is down 17 per cent this year, has now offered existing clients a chance to put new money into a healthcare-focused side fund, with no fees of any kind.
Of course at the end of the day, if you're losing double-digits, it really doesn't matter if the fee is 1 and 15 or 2 and 20 - you're losing money and underperforming benchmarks that can bought via ultra-low cost vehicles and on that note, we'll close with the following quote from Emma Bewley, Connection Capital’s head of fund investment:
“If you’re pushing for lower management fees to save minimal basis points on a fund where you are unhappy with performance, as a fiduciary, you have to decide whether you want to keep that fund at all.”
