Headlines about high-profile hedge-fund closures and performance troubles commanded the industry’s attention in 2018. A year that started with promise for both established managers and new players quickly tanked after the second quarter’s close. Fees are pushed lower with every new fund launch, and large managers like Dmitry Balyasny’s firm laid off large swaths of staff. On top of all the industry pressures, the markets in the fourth quarter lobbed off any kind of returns many managers had managed to squeeze out so far this year — through the end of November, hedge funds had lost 2% on average, according to Hedge Fund Research. Going into 2019, industry observers and participants believe these trends will dominate the conversation: Equity funds will be put to the test It’s time for long-short funds to prove their worth. After nearly a decade of a tranquil, post-crisis bull market, when equity hedge funds on average finished in the black but rarely beat the S&P, market volatility in 2018 has given investors reason to turn to active management again. Now these equity hedge funds have to prove to clients they’re able to crank out positive returns with the markets in constant spasms. “More and more people believe the large-cap developed index is highly efficient, and it’s very hard to deliver any excess returns,” said Don Steinbrugge, CEO of the hedge-fund consultancy Agecroft Partners. “You consistently have to be doing more.” Steve Cohen, the founder of Point72 Asset Management. Point72 Long-short strategies still hold the highest proportion of assets of any hedge-fund strategy in the industry, according to Troy Gayeski, a senior portfolio manager at the fund-of-funds manager SkyBridge Capital, with 40% to 50% of industry assets under management. The hedge-fund industry’s asset total — more than $3.2 trillion — was partially inflated by this equity exposure during the market’s long bull run. If long-short players can’t keep the returns up during bouts of volatility, then industrywide assets will start to slip because of poor performance and investor outflows. With a lower benchmark to beat, equity hedge funds would be under the microscope in 2019. ‘2 and 20’ will continue to fade away The 2% management fee and 20% performance fee structure typical of the hedge-fund industry’s early days has been slipping away for years. Hedge Fund Research reported that only 30% of the industry had fees at or greater than the traditional “2 and 20” rate. The average management fee has fallen to 1.43% industrywide, and incentive fees sat at 16.93% as of the end of the third quarter, according to the data provider. Part of the squeeze on management fees comes from public pension funds pressured by legislatures to lower the fees on their portfolios. The Teacher Retirement System of Texas — the biggest US pension fund in terms of hedge-fund assets, according to data from Preqin, with $14.7 billion of its $151 billion portfolio allocated to hedge funds — has since 2016 pushed hedge funds to accept a 1% management fee and 30% performance fee structure, according to Brad Gilbert, the pension’s senior director of hedge funds. “The traditional hedge-fund fee structure is flawed,” Gilbert said at an April meeting of the pension’s board. Managers will battle more than just one another for top talent Much as in investment banking’s battle for top tech talent with the Googles and Facebooks of the world, hedge funds looking to up their technology game are finding that they are competing against more than just the manager down the street. Hedge funds are looking to hire in positions from systems and data engineers to machine-learning specialists, but they are losing out to Silicon Valley for top talent, said Peter Wagner, CEO of the recruiting firm Affinity North. Of the compensation structure in the hedge-fund world, he said that with the “bonus-weighted culture, a few bad years leaves people very disillusioned.” Google CEO Sundar Pichai. Getty Jobs at big tech firms like Google that are developing new products and are at the front lines of tech innovation may be more fulfilling for tech workers than a job at a typical hedge fund, Wagner said. Old-school trading systems at older hedge funds have forced some industry tech roles to focus on maintaining legacy products instead of building new ones. And that’s not to mention the compensation upside. “It’s very easy for a Facebook to add stock shares to an offer, and it’s very cheap for them to do it,” Wagner said. “There’s no real equivalent on the hedge-fund side.” More fund-to-family-office transitions Some older hedge-fund founders have struggled to keep up with the market over the past couple of years, or have just decided it wasn’t worth the effort to keep pushing off young startups, cranky investors, and aggressive regulators. So the allure to “close it down” is understandable, said Adam Zoia, CEO of CompIQ, a consulting and database company in New York. “They’re saying, ‘You know what? I don’t have the energy to wait around for another moment where I might outperform,'” Zoia said. The billionaire Leon Cooperman said exactly that in July when he announced he would turn his $3.6 billion hedge fund, Omega Advisors, into a family office by the end of the year and return outside capital to investors. “I don’t want to spend the rest of my life chasing the S&P 500 and focused on generating returns on investor capital,” Cooperman told investors in a letter. Cooperman, who turned 75 this year, founded the firm in 1991. The multibillion-dollar funds Highfields Capital Management — founded by Jonathon Jacobson, a former Harvard endowment stock-picker — and Ascend Capital also announced transition plans to investors in the fourth quarter. Leon Cooperman. Reuters/ Rick Wilking “After three-and-a-half decades of sitting in front of a screen, I realized I am ready for a change,” Jacobson said in an October letter to investors, alerting them that he would be returning outside capital. “It’s not a great time to be in the hedge-fund business, relative to other times,” Zoia said, adding that this kind of stagnation is common for a “maturing industry.” Put another way, the “insulation” protecting the industry from external forces has gone away, said Gary Stibel of the New England Consulting Group. “There’s going to be unhappy people on both the investor and the manager side” next year, Stibel said. The hunt for differentiated data will be even more cutthroat It doesn’t matter what your hedge-fund strategy is — the need for differentiated data is universal. And there has been a boom in alternative-data providers because of it. According to AlternativeData.org, there are roughly 375 companies offering some new form of data. The ones known best in the industry have now become table stakes — without their information, a manager is automatically starting at a disadvantage. But more niche players have cropped up, using natural-language-processing software to scan what traders are saying on Twitter, as well as integrating CIA interrogation techniques into a model to determine when company executives are being deceptive on earnings calls. “People’s needs keep changing, and the data sets keep changing,” said James Crane-Baker, the CEO of PsychSignal, which scans and scrapes the social-media posts of traders and sells the data to quant hedge funds. The most successful funds in the future, Crane-Baker said, will be the ones that employ the data buyers who “travel the world looking for new data sets.” Well-known Wall Street firms seem to be paying attention to this boom in both data collection and data budgets. Third Point Management last year recruited Matt Ober, WorldQuant’s cohead of data strategy, to be its chief data scientist, while Nasdaq has purchased two of the hedge-fund industry’s biggest data providers, eVestment and Quandl.
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