While some famous activist investors have experienced hedge fund horror over the last year, and most hedge funds have sharply underperformed their investors' expectations, forcing fee cuts to try and stave off redemptions, two of the handful of names who have been outperforming in the industry are now increasing their fees and extending the amount of time it takes for investors to redeem.
Millennium and Citadel are two funds that have managed to stand apart from the deplorable 2 and 20 herd, and performed solidly over the last couple of years. And now they are - one way or another - raising their prices for investors. Millennium, after recently telling investors they would get their profits early next year, also told investors that to reinvest these profits, they need to sign up for a new share class that would extend their redemption period from one to five years, ostensibly to avoid forced sales during the next recession and effectively giving the hedge fund a private equity-like lock up.
The new share class at Millennium also no longer lists its founder Israel Englander as a "key man", meaning that investors can’t take their money out if he leaves.
Citadel is also working on changes to how it charges investors for several of its hedge funds.
Unlike most of their peers, Citadel and Millennium can make these aggressive demand because they both have a backlog of investors who want to invest with them. Since inception, Citadel and Millennium have averaged 19.1% and 14% annually, respectively. For the previous decade, Citadel averaged 8.9% annually and Millennium averaged 10% annually. Before October, Citadel's flagship fund was up 13.5% for the year and Millennium was up 8.3% for the year, according to the Wall Street Journal.
Both funds have far exceed the 1.4% average gain by the broader hedge fund space during the same period, while the S&P was up 10.6% over the same period of time.
Meanwhile, the premise of hedge funds that actually hedge is gradually becoming appealing again as the market stagnates amid spasms of rising volatility, and becomes more conducive to stock picking as opposed to "asset managers" who have invested by throwing an ETF or mutual fund dart and hoping all stocks rise alongside the market. Incidentally, in recent years the dart has outperformed even the smartest money in the room.
Kieran Cavanna of Old Farm Partners told the Wall Street Journal that "It’s very hard to find someone who can consistently do well. There just is not enough capacity for the amount of money that wants to go into those firms."
During the financial crisis Millennium only lost about 3% while the market cratered. Even so, its AUM dropped from $14 billion to $7 billion at the time, mostly because it was the most liquid of all the hedge funds and people were trying to get their money out of any place they could and had not imposed "gates" on investors. After the crisis, in 2009, Millennium founder Englander famously stated at a Morgan Stanley hedge fund conference that those who wanted to get their money back "should’ve invested in a mutual fund" instead.
Similarly, Citadel plans on returning profits at the end of the year this year. Clients that want to reinvest these profits have to pay a new 1% annual management fee that starts in 2019, on top of the expenses that they already pay. However, the new fee will count toward the performance fee, which means that if the fund makes money over the year, the overall amount customers will pay will remain relatively unchanged.
In other Citadel funds, the company is employing a model of charging clients for variable expenses that it passes onto them, rather than just a flat 2.5% management fee that it had previously charged. But those funds are also dropping performance fees from 25% to 20%. When returns are lower, investors should pay less under the new fee arrangement, but at the same time if Citadel can continue outperforming, clients will wind up paying more while being locked up for a long, long time during the next market crash.
Then again, in the increasingly disappointing hedge fund world, that’s just the cost of handing over your money to one of the few who can still generate alpha successfully.