MM have crushed SM last few years - is this an obvious trend over next decade or just reversion? You had multiple years where Baly struggled, citadel shut down divisions (aptigon, ravelin) and now they are all humming at same time. I get sense that data + mgmt access importance has advantaged MMs but at same time SMs have gotten smarter on risk mgmt while having less constraints on risk taking
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They are different products. SM fees likely need to come down before they get back to big inflows (you shouldn't get paid on simple net exposure, period.) but last few years were also perfect period for MMs with massive macro vol/dispersion, and were a period where the data edge was much more material. Also far more capital in pod land now which is a headwind for MMs.
Probably was a cyclical upturn for MMs within a secular theme (albeit that secular trend is likely slowing now). I think SMs still have some secular challenges, but the cyclical headwinds likely are abating.
Frankly, hedge funds in general are a better product than they were in 2015-2019 purely based on short rebate. If short rates maintain at 5%, makes it so much easier to pitch hedge funds as a viable product since that basically adds 3/4% of risk-free performance every year. People often don't realize that equity hedge funds are just as much a short-rate bond product as they are an equity product (you normally get 60% of short rate yield + 30% of net exposure as the baseline return prior to spread/alpha).
Wouldn’t rates consistently being at 5% make it harder to pitch a HF? Why take on equity risk via a typical LS equity product when you could be essentially risk-free at 5%.
Also, funds generally just underperforming. I know a HF is supposed to be a “hedged” product so can’t expect maximum market return but looking at like Third Point LS underperforming and many others undeperforming vastly compared to S&P (ik mostly bc run in the m7 companies).
Why invest in a HF right now? Why is it different than 2015-2019?
Allocators view L/S hedge funds as a substitute for their equity long only exposure. So as the ERP goes down/RFR goes up, and hedge funds benefit it, makes their forward looking returns more attractive vs long only equities since multiple on equities haven’t moved.
Larger funds underperform, agreed. It’s basically impossible to run a real L/S hedge fund with >$5B in AUM just due to liquidity so it’s no surprise the big ones do poorly (ex pod shops, which is obv different).
Pitch for equity L/S low or zero net hedge funds vs long only equities is much better now than 2015-2019, and that’s what matters from an allocation perspective (not the pitch of L/S vs short rate bonds, even though your right to say that it should matter).
Even though higher rates implies higher short rebate on the short side, don't MM HF also incur higher borrowing costs to fund their long book so the impact of higher rates net out..
It’s secular there’s not really a debate here
SM is a bad product. It’s inferior to MM and to passive ETFs. The latter of which is particularly offensive since the fee rate is an order of magnitude higher.
That’s not a sustainable business model. It’s gone on as long as it has because allocators are basically beaurocrats playing with other people’s money. As soon as they concede that there’s no value add in manager selection and a monkey can do better than their roster of flunkees, they no longer have a reason to exist.
Both. I think if you're trading large cap liquid equities then MM dominates. They have economies of scale for getting management access, data, trading systems, risk management, and perhaps most importantly, talent.
There are some things MM's are inherently bad at:
1) Anything that involves liquidity constraints (e.g. small caps)
2) Anything that involves unhedgeable asymmetry (e.g. clinical outcomes type biotechs)
2.5) Really anything too event-driven is tough. Event risk is typically unhedgeable and leads to risk-limit breaking movements
3) Anything that cuts across industry/ style buckets (MMs need this to underwrite and hedge your risk)
As MMs become bigger part of industry I actually think there is more alpha being left on the table in the buckets of things MMs are bad at/ won't do, while there is less alpha in trading liquid large caps.
So yes, the secular logic is that SMs that do things that would fit well within a MM framework (1 or 2 sector low net long/short) should continue to shrink relative to MMs. People that are doing completely different things can thrive.
Can you explain the event driven piece more? I'm at a generalist SM looking at a SpinCo and recent 13Fs have shown pods showing up as large shareholders. If they were long the SpinCo and short something else as a hedge (S&P, industry index, peer, etc.), what could happen to them? Or are you just saying referring to events with major moves like merger arbs or biotech trials like you mentioned?
What would an example of a fund that falls under category 3?
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