Why are previously successful hedge funds failing?

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I work for a LO manager. I have a little less than five years in the industry although have prior work experience. We do fundamental work and average a two year holding period. I see opportunities to generate relative outperformance in many places. I do not think it is easy but would think it is possible for the collective intellectual capabilities of previously successful hedge fund managers.

So I am really curious as to why these funds are failing sort of en masse (Eton Park, Perry Capital, Brevan Howard, etc.)? I recognize that some of these funds are macro-oriented but I feel like even the equity-focused long-short players have struggled as well.

I have a couple of hypotheses. These are based on trying to identify something that has changed over the last say five years or so.

For macro funds maybe QE everywhere has distorted historical relationships. Government intervention is notoriously unpredictable, especially for the libertarian hedge fund crowd that may be less amenable to "non-rational" thinking.

But more focused on long-short/stock-picking funds, what has changed?

Another possibility is the rise of high speed trading. It seems to me that a good number of hedge funds historically have been founded by "traders" (as opposed to say an equity research guy). A trader generates alpha by having short-term information advantages. I suspect that the ability to exploit these short-term advantages has been eroded by high speed trading. For a generic example, "word" comes to connected hedge funds that numbers are too low for a given company. They begin to initiate a position but algorithms pick up on the trade and increase the cost. There may be other variations of this theme.

I acknowledge headwinds from the publicity associated with the fee structure and/or historical claims of consistent quarterly outperformance. The former has no effect on performance. The latter does but funds have always pitched this.

For those of you in the industry, what has changed?

Or maybe I am mistaken that the long-short fund industry is struggling?

Comments (56)

 
May 20, 2017 - 10:29am

"En masse" is a curious choice of terminology...

Have you considered how much AUM these famous funds represent? Especially as %age of the industry AUM?

It's a complicated dynamic, overall, but it's hard to generalise when the industry AUM continues to hit all time highs, names or no names. And, btw, Brevan isn't closing down, like the other two examples you've given.

 
May 20, 2017 - 2:55pm

Sometimes you have bad years

Absolute truths don't exist... celebrated opinions do.
 
May 21, 2017 - 11:39am

<span>wso23</span>:

None of these are structural except for #3. Why is it more competitive?

I'm not saying it's structural...but to answer your question, it's more competitive because the industry is on the whole much larger in terms of AUM than it was 10-20 years ago when these guys got their start, and the informational/analytical edge is narrowing.

 
May 21, 2017 - 12:43pm

Yes, markets are deeper, more liquid and respond to information more rapidly (in part due to HFT). In an efficient market, there's little room for alpha, particularly among traditional money managers (CBS style fundamental analysis is a relic). This is the argument I've made almost two years ago on this forum. You have seen and will continue to see fund outflows, fee pressure and general consolidation. Certain regulatory barriers have contributed as well.

“Elections are a futures market for stolen property”
 
May 23, 2017 - 2:56am

<span>Esuric</span>:

Yes, markets are deeper, more liquid and respond to information more rapidly (in part due to HFT). In an efficient market, there's little room for alpha, particularly among traditional money managers (CBS style fundamental analysis is a relic). This is the argument I've made almost two years ago on this forum. You have seen and will continue to see fund outflows, fee pressure and general consolidation. Certain regulatory barriers have contributed as well.

What is CBS style fundamental analysis?

 
May 21, 2017 - 11:50pm

I run a very small portfolio. (think small mini-fund).

Since mid 2016, there's been a detachment of fundamentals and market performance.
Macroeconomic "hard data" fell off a cliff, yet stocks continued to make all time highs.

Lots of funds initiated large hedging positions in 2016, with some going net short.
The outcome is obvious.

Case in point - John Paulson's fund was down 18% in 2016. That's outrageously poor performance.

Trump effectively rallied the markets to historic highs, while simultaneously "breaking" it.
Broken, as in detached from common sense. Euphoria, animal spirits, and a general complacency has taken over.

How long it'll last is anyone's guess. All I can say is, a LOT of managers are short.

 
Best Response
May 22, 2017 - 3:00am

Very very few hedge funds actually have a process/ infrastructure in place that's more than "we have a smart CIO and smart analysts are cheap." If the CIO is unlucky or dumb (and they tend to get dumber/ lazier as time goes on) then its all over. The real question is why so many mediocre big funds remain open

 
May 23, 2017 - 4:49am

This is tough b/c its constantly evolving and a lot of it is organizational structure type stuff.

Basics/ before: Repeatable investment process not dependent on the CIO bing brilliant at decision making, personnel processes to continually recruit and retain best talent. None of these things are/were really about capital

Now (increasingly): Heavy technology and research/ data investments. Heavy compliance investments. A lot of things that require upfront capital investment.

Some of the firms with the technology, research, etc are actually kind of terrible on the people front (think multi-managers) but it doesn't matter b/c smart ppl are a plentiful and cheap and you can churn them through the system

What's amazing/ annoying is how many funds have neither of these things, but once had a really smart CIO put up huge numbers and ride that reputation forever despite no longer being any good

 
May 27, 2017 - 1:19am

dazedmonk:

Very very few hedge funds actually have a process/ infrastructure in place that's more than "we have a smart CIO and smart analysts are cheap." If the CIO is unlucky or dumb (and they tend to get dumber/ lazier as time goes on) then its all over. The real question is why so many mediocre big funds remain open

Ok but I am talking about funds with previously great track records and presumably genuinely smart CIOs. Luck does not explain what seems to be a wave of closures either.

I am not arguing that most hedge funds are good investments. I am questioning why so many successful funds seem to be struggling. Are you saying that the funds I have listed really persisted on a motivated (now unmotivated) smart CIO and/or luck?

 
May 28, 2017 - 7:29pm

I'm saying that the funds persisted on early performance, which was largely based on smart CIO/luck/ less competition. There are a bunch of big funds like this that have been completely mediocre for 5 or 10 years but get the benefit of the doubt. They are gradually (and appropriately) being replaced by new blood

 
May 22, 2017 - 10:52pm

HF's make the bucks by bringing money in, not beating the market. Although it's common for someone to think they are failing because they are down %age wise, its important to note that hedge funds, among other funds, have bad years.

"For example, a hedge fund managing $1 billion charges a fee of 2% of those assets per year plus 20% of trading profits.

Let's assume the fund breaks even — no profits. That's still $20 million in fees. When a hedge fund controls $20 billion, the income is $400 million."

This is the structure of fee's. Now assume the fund continues to perform like shit, then, guess what? People are going to pull their money.

With this in consideration, hedge funds don't necessarily have to promise anything. They perform well collect the fee's and then their children have a decent 20 million sitting in their trust funds. This can bring about a sense of complacency. "We do it big for 5 years, everyone eats, we collect more assets, then we can relax." Unfortunately, there is no relaxing in the market, but they know exactly what they are doing

People like Ackman will continue to perform well because they are all about making a name for themselves, and once they have made it, they need to ensure that it stays polished.

Whats the solution? Lower fee's and operate on a profit performance basis. This will ensure that grifters are put to rest, and hedge funds wont just milk people for fees.

"He who makes a beast of himself gets rid of the pain of being a man" - Samuel Johnson
 
May 23, 2017 - 11:31am

Well, first people got to understand that the structural behavior of market have dramatically changed.
We went from de-correlated market to fully correlated market (known as risk on/risk off dynamics).

The beta has never been so high. So just assuming that, it's kind of difficult to generate extra income from the whole market since asset tend to follow each other.

Just an example : Commodities market were highly structured on a fundamental supply/demand dynamics. So that hedge fund and CIO would have their "niche" play were they would make most of their ALPHA. However now that correlations rythm the market there is way less strategy available. I m talking from a discretionary view.

From my point of view (futures trader here) i think there is still lot of "easy" strategy who can generate ALPHA but they are MOSTLY short term. Indeed as we said earlier Hedge fund are constrained by huge amount of capital so that they need to enter on large large positions otherwise transaction cost would affect their margin hard.

 
May 23, 2017 - 5:32pm

Have you considered that it is a matter of pride and honor? The guys running these funds have figured out that they are siphoning fees from the retirement/college/mortgage savings of people far, far less wealthy than they are and using them as table stakes for a giant coin flipping contest.

I'm sure that you genuinely do see upside in your equity picks. Does anyone go long on stocks that they think are going to decline or underperform the broad market? The percentage of stock pickers who can actually outperform the market is probably in the 1-2% range. Once you've figured out that you're in the other 98-99%, it's best to devote your life and energy to something different.

 
May 25, 2017 - 6:48pm

A few reasons:

-Fees have generally been too high in the past.

-Hedge funds are designed to provide uncorrelated returns, not beat indexes. Its not surprising that they are not beating indexes (especially after fees) when they were never designed to do so.

-Due to downward pressures and unwarranted pressure to beat indexes, a lot of funds are more or less closet indexing, so they underperform indexes (after fees) while being more or less correlated.

-A lot of funds rely on a one particular persons prior record to raise money with no promise of actually recreating those results or proving it was anything other than luck.

-We have been in an almost decade long bull market. Active management underperforms in bull markets and overperforms in bear markets - in general.

-Picking individual stocks is very, very hard to do consistently over the long term. Even if you can, most of the time it is just survivorship bias / extended period of extreme luck.

-Investors in hedge funds do not understand investment processes or how to track returns, so they pull $$ at the first sign of things going south.

-People like Buffet are popularizing the notion that hedge fund managers are taking exorbitant fees while not providing much in the way of alpha.

-People in general, are starting to hate hedge funds even more than in the past for whatever reason (Bernie Sanders? Idk)

 
May 27, 2017 - 1:40am

bballchamp2:

Because there's no talent anymore! Just ask Steve Cohen!

I saw this quote and thought it was really interesting. What is he talking about? Why would there be less talent?

Is he just saying it is more competitive for recruiting talent?

That lines up with the thesis that the industry has become hyper-competitive. The comparison might be to apparel retail today where you have countless online start-ups burning cash to gain share while fast fashion and discount players disrupt department stores and legacy branded retailers.

If the analogy holds, then we should see fund "start-ups" taking share. It is tough to gauge if this is actually happening.

 
May 26, 2017 - 11:41am

Here's another reason: LPs have (finally...jesus it took them look enough) realized that paying AUM fees is idiotic, and they're not doing it anymore.
Voila, running a giant fund no longer makes you rich just for showing up, which in the bad old days of 2% AUM it did. (Think $5bn fund charging 2% of AUM, with a couple dozen employees max).
It is no surprise then that managers are thinking really hard about their real ability to generate alpha, if alpha is the only thing that's going to get them paid.

 
May 26, 2017 - 12:39pm

markets arent really markets where fundamentals matter anymore

its about algorithms and cheating these days

alpha currency trader wanna-be
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