Blackstone's Joe Dowling likes these strategies for hedge funds

Pensions & Investments sat down with Joseph Dowling, now in his third year as senior managing director and global head of Blackstone Alternative Asset Management, a division of Blackstone.

When asked about 2023 market conditions for hedge funds, Mr. Dowling noted that the "Darwinian nature of the industry is accelerating." He also stressed that it's tougher to start a new fund today.

Mr. Dowling and his team managed a total of $78 billion as of June 30 — $50 billion in hedge funds of funds and managed accounts and the remaining $28 billion in other alternative strategies including direct investments, special situations, private equity stakes, seeding, dislocations, a crossover fund and a division that manages money for wealthy families.

P&I no longer tracks hedge fund-of-funds managers for its annual hedge fund report.Questions and answers have been edited for style, clarity and conciseness.

A: The first one is … the Darwinian nature of the industry is accelerating. You have increased regulation and the market has been challenged for returns and now more than ever you need scale. We can go back and talk about multistrategy. That's the area that has grown the most. That segment is $300 billion now, of which the top five players control 50% of the market.

So that's one. It's tough to start a hedge fund. It's a great time to be a seeder of hedge funds, which we do, because the capital is in charge. You go through periods of time where the capital is in charge and times where the manager is in charge.

A: Capital meaning we can set the terms and seeding because it is difficult to start a fund. The second theme is … the shift from quantitative easing to quantitative tightening. In a QE market, beta and high-net (long the market) ruled in terms of performance. QE was jet fuel for equities. In a QT market, you have more volatility, more dispersion and markets don't always go up, so hedge funds are used as insurance against a flat or down market. The strategies that have been working the best are the multistrat trading-oriented managers, low-net managers, macro and quant. In a QE world, people thought that these low-net and trading strategies had pedestrian returns ... who wanted 8%-10% when the stock market was booming, year after year after year? I think 2022 really woke people up.

A: So what you see with lockups is that the multistrat (hedge funds) have really shifted. They've all lengthened their lockups and why? Because there's a scarcity factor. The average hedge fund cannot do it, but in a multistrat fund if you are in that elite category, then you can command what you want. It's just supply and demand.

In terms of multistrat, especially the elites, they have proven themselves to be consistent stewards of consistent high risk-adjusted returns, so they can demand better terms because of the scarcity factor.

A: So absolute return for me is exactly what these multistrats are trying to do. They are trying to make money irrespective of what happens in the markets. If the markets go sideways they make money; the markets go down, they make money; if the markets go up, they make money.

For us, you do that by making sure you set your asset allocation correctly. So what's your mix? We are pretty balanced between credit, quant, macro and equities. Those are our four buckets. Then within each one of those buckets, you have different style managers. You need to decide when you put them together; it's like making a great meal, you have to have all the ingredients to be measured correctly. The way you construct the portfolio is critical to how it performs. How big should you make each bucket? How big should you make each manager? After 2022, I think people now understand the power of the absolute-return asset class.

A: We deal with all the consultants and I think 2022 was a big wake-up call for them when they saw that we were up in 2021, up in 2022 and now up in 2023. I'm coming up on three years, David Ben-Ur, senior managing director in BAAM and the chief investment officer of the unit's portfolio solutions unit, is coming up on two years, our team's really starting to click. We are very happy with how the portfolio is constructed.

A: Each one of those buckets would have tools that we would use including things like co-investments, overlays for hedging, direct investments.

A: I would say that when you are doing well, people are not asking for fee reductions. I mean the multistrats are the ultimate and the opposite of fee compression because of the pass-throughs (where a hedge fund manager charges investors in their fund with underlying expenses such as compensation, technology and research rather than charging a fixed management fee).

A: It's a great question. So the Fed's balance sheet is being lowered by $95 billion a month — $60 billion in Treasuries, $35 billion in mortgage-backed securities. So to just get the Fed's balance sheet from $8.5 trillion down to $4.5 trillion you are talking about three to four years.

It's going to be a problem for people who don't know how to construct portfolios, don't know how to insulate themselves in this new environment.