Spoke with 2 MDs at a top BB (GS/MS/JP) recently and both said that HFs have been very stagnant for the most part and it isn’t as appealing as it once was (also have seen a lot of turnover in their group). They work in the AM arm and focused on hedge funds for decades so I feel they know what they’re talking about. Curious what your thoughts are if it’s just them being cynical or not. I’m interested in potentially going over to a credit hedge fund and working my way up.
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There will always be a market for people who can make money or talk like they're going to make money. Do what you want.
Its a tougher environment for anyone who isn't generating real alpha. I think the most accurate way to look at it, is that its moving to more of a barbell shape distribution. On one side you have real alpha generators (high fees for real outperformance) and on the other side you have index funds (zero outperformance and almost zero fees).
Previously, there was more of a middle . . lot of mutual funds charging medium fees for minimal alpha, or hedge funds that were claiming outperformance but not delivering. As allocators have gotten smarter, the middle has hollowed out.
For an example, look at smart beta. 3-5 years ago, smart beta was the hottest thing in the industry and the ultimate "middle" product. Charge people 30 bps for the hope of slightly beating the index. Now people are starting to call bullshit on it. Still very much around but AUM is down at places like DFA and AQR because allocators have become more sophisticated and want to know why these strategies are likely to deliver alpha in the future, which they aren't.
I know smart beta gets outside HFs but wanted to use it as a clean concept to illustrate the barbell.
I think the 2 MD's may be technically right, but its the wrong attitude to have. If you believe with high conviction you can deliver outperformance, you should be in the industry. And if you don't believe that, you shouldn't.
Nah maybe credit hedge funds but quant hedgefunds are consistently outperformers. I have yet to hear of Citadel or Jane street losing money they also pay like 500k out of school if you can hack their interview.
Very uninformed comment. Jane St and Citadel (hedge fund) are in completely different busineses. Better to compare Citadel Securities and JS.
500K out of school is not recurrent, it usually comes with 150-200 sign on. After that it is really 300-350K. And in those places there is no "unlimited" upside -- people are often capped at 700K-1M.
Going back to the OP... I'm not sure the HF industry is dying, but the easy money has mostly been made. The industry is crowded (too crowded, I would say), fees (management and performance) are generally coming down, and its getting harder and harder to start your own shop. In short, like someone else above has probably said, the industry is evolving. It's no longer that "sexy, edgy" industry where someone can rock up to a fund and make a ton of money early on. Investors (LPs) can be far more picky and demanding, whether its information requests, certain operational procedures/standards, returns targets or just plain old fee levels.
Generating "alpha" whatever that really means is getting harder and harder and at least from what I see, life-cycles of people/funds are getting shorter and shorter. The big funds are hoovering up most of the talent and have the best resources. Then there are some great niche-y places that do well but can't scale. Then there is everyone else....
My humble opinion having spent ~4 years in the industry...
The rise of passive investing / ETFs has and will continue to be a headwind. Allocators and investors will not be content with average performance when it can be replicated at a lower cost.
The low interest rate environment and until recently stable economy has been a great tailwind for the private equity industry. On paper, PE funds have been an attractive alternative to hedge funds and have delivered attractive risk adjusted returns. The competition from PE over the past decade is far greater vs the 90s / 00s.
During the 2000s hedge funds did have a good run and delivered attractive returns, partially driven by the fact that value strategies worked well (and I believe higher short rebates which aided returns). Post 2008, market leadership has been concentrated to a subset of tech names, volatility (until recently) has remained low, and traditional value investing has underperformed.
The combination of these factors has led to a relative outflow of capital from hedge funds. Simply put, new competition, high fees charged by hedge funds, and lackluster performance have greatly hurt the industry. Hedge funds have not replicated performance delivered in the 2000's and allocators / investors have put average hedge funds on a short leash and have put downward pressure on fees.
That said, if you're smart and can deliver alpha, investors will still allow you to charge hefty fees for outperformance and there are still a subset of funds which continue to deliver. The market will always reward and allocate capital to talented investors. If you believe you can deliver alpha there is room for you in the industry and you will likely succeed.
In addition, it's not theoretically possible to have a market completely filled with passive ETF ownership - there always needs to be active investors in the market taking advantage of price dislocations. Though if you can't deliver performance, good luck charging significant fees.
While the outlook may seem bearish, there are a few reasons why hedge funds can come back in favor (though gone are the days of unestablished funds charging 2 and 20 on new money)....
A rising rate / inflationary environment and higher market volatility should in theory make hedge funds more attractive and increase their probability of achieving outperformance. Private equity vehicles also become less attractive given higher costs of financing debt.
If we see a paradigm shift from limited market leadership (ie FAANG and growth tech), to value based strategies outperforming again - this would be beneficial to hedge funds.
I also think the PE universe is too crowded with small / unproven funds launched in the past decade. A rising rate environment / a recession such as this one will test their skill. Assuming we see a wave of portfolio company failures, investors will not enjoy the long workout process and come to appreciate liquidity available in the public markets.
Headwinds: * Most alpha is zero sum and getting harder to find (most of the losers have died out, e.g. underperforming mutual funds) * Some "alpha" is not zero-sum, but people are trying to re-define it as beta and offer it for free * Allocators best suited for HFs are going out of business / losing capital (e.g. corporate pensions being replaced by 401ks, most pensions being underfunded) * Unfavorable tax treatment of gains relative to other options (new laws are a double whammy).
Tailwinds: * Cash and beta yields are at historic lows - nowhere else to generate returns. * Correlation properties of assets have changed such that investors are in desperate need of diversifiers (e.g. bonds will not diversify equities the way they have historically).