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The hottest sector in the hedge fund industry has suffered outflows for the first time in seven years, in a sign that investors who once raced to get access to so-called multi-manager funds may finally be losing interest.
Pioneered by firms such as Ken Griffin’s Citadel and Izzy Englander’s Millennium, multi-manager hedge funds house tens if not hundreds of trading teams, known as “pods”, which run a variety of trading strategies across equities, commodities, foreign exchange, credit and other markets.
These funds have pulled in tens of billions of dollars from big investors in recent years thanks to and strict risk controls and consistent returns, even in equity bear markets such as 2022.
But a report by Goldman Sachs seen by the Financial Times shows that these firms have experienced net client withdrawals of more than $30bn in the 12 months to the end of June, the first time they have suffered outflows since 2016.
This is a “significant turn in the tides”, said Goldman in the report. “There has been a turn in allocator sentiment and the flows picture reflects this lower appetite.”
The data was compiled by the prime brokerage division of Goldman Sachs, which lends money to big investors such as hedge funds to make bets in the market, and was based on a sample of 53 firms with $366bn in assets. About one-third of the $30bn figure was due to hedge funds choosing to return capital to investors.
The biggest driver of waning investor demand is that, after years of increasing their investments in the space, some allocators such as pension funds have decided that they have now invested enough, said Goldman.
But weaker returns last year have also dented investor enthusiasm, with a gap emerging last year between larger, more established players such as Citadel and Millennium, and smaller firms, some of whom did little better than the return from cash. Dmitry Balyasny’s Balyasny Asset Management and Schonfeld Strategic Advisors gained 2.7 and 3 per cent, respectively, at the end of last year.
“The average multi-manager return in 2023 was almost identical to the risk-free rate for the year,” said Goldman in the report.
The bank’s data showed that over the past year there was a 13 per cent difference in performance between some of the best and worst performing managers.
Some of the top managers in the space, such as Millennium and Citadel, have been mostly closed to new investor money in recent years, although Millennium this year has been in talks to raise potentially billions of dollars for a pot of additional cash that can be drawn upon when the firm desires, according to a person with knowledge of the matter.
The bank also attributed the waning interest to increasing charges in the sector.
The rise of multi-manager hedge funds has been fuelled by the so-called pass-through fee model, where all costs such as client entertainment, office rents and bonuses are charged directly to investors, in addition to a performance fee. That can lead to annual fees that can vary from 3 per cent to 10 per cent of assets. In contrast, hedge funds on average charge a management fee of 1.35 per cent, according to data group HFR, to cover their costs, plus a performance fee.
The high fees have enabled these firms to offer some of the most lucrative pay deals in the industry, fuelling an escalating war for talent, but it has also put pressure on these hedge funds to continue delivering returns to keep pace with their costs.
In a sign of the sector’s rapid growth, Goldman found that over the past 12 months, multi-manager hedge funds added about 2,400 new hires, with a 19 per cent and 13 per cent increase in non-investment and investment staff, respectively.
Despite a mixed year for performance last year, the picture has been far rosier this year, with firms such as Balyasny and Schonfeld delivering better returns.
The bank added that while sentiment seemed to be changing for the worse, the sector was “showing no signs of losing its importance and relevance” in the hedge fund industry.