Multimanager funds changing industry, but hurdles remain

The hedge fund industry has been dramatically changed by the rise of a cadre of hedge fund firms that employ dozens, and in some cases, hundreds of investment teams to manage billions.

But the high fees they charge, longer locked up capital and capacity constraints have not been endearing them to many institutional investors so far.

In the past five years, sources said multimanager hedge fund firms have transformed the venerable single-manager multistrategy hedge fund model from the 1990s to a new level of investment management.

Multimanager hedge fund firms have created a "super league" of hedge fund managers, said Daniel Celeghin, managing partner of money manager consultant Indefi LLC, New York.

These firms are hiring the most talented investment, risk, operations and technology employees; acquiring the most advanced technology; building the most sophisticated risk management systems and quant-driven asset allocation models; implementing tighter redemption rules for investors; and charging some of the highest fees in the industry, Mr. Celeghin said. "They're really playing in a very different league than other hedge fund managers."

Some of the industry's largest multimanager firms provided their worldwide hedge fund assets under management as of June 30 for Pensions & Investments' 12th annual hedge fund special report:

• Millennium Management LLC, New York, managed $52.3 billion, making it the fourth-largest hedge fund manager in P&I's ranking and up 19.1% from the year before.
• Chicago-based Citadel Advisors LLC's trading teams managed $37.6 billion as of July 1 and held the ninth position on P&I's list, up 9.6% for the year.
• Point72 Asset Management LP, Stamford, Conn., held the 19th spot with $21.8 billion in AUM, up 26.7% for the year.
• ExodusPoint Capital Management LP, New York, managed $13.5 billion, up 12.5%, and ranked 27th.
• Balyasny Asset Management LLC, Chicago, managed $10 billion and ranked 38th, increasing assets by 42.9% for the year.
• Schonfeld Strategic Advisors LLC, New York, managed $8.1 billion and ranked 49th, up 46.1%.

Multimanager hedge fund platforms have evolved and "grown so much in the past five years. These firms were not this large 10 years ago," said Samuel M. Diedrich, a New York-based managing director and head of absolute return and credit at OCIO manager Partners Capital Investment Group LLP, in an interview.

Partners Capital managed a total of $43.6 billion in OCIO assets of which $8.6 billion was invested in hedge funds as of June 30.

Millennium Management, for example, experienced asset growth of 52% in the five years ended June 30, based on the firm's responses to P&I's annual survey, while Citadel's AUM increased 38.7% over the same time period. Five-year data wasn't available for the other multimanager hedge fund firms P&I analyzed.

A strong impetus behind the growth of assets is the attractiveness of their returns, Mr. Diedrich said. "These managers have incredible pricing power because with the multiteam approach, they've harnessed the power of diversification on steroids," given the breadth of their trading, investment and asset allocation capabilities.

As a group, multimanager firms tend to produce risk-adjusted net returns ranging between 8% to 12% with little to no market correlation, moderate volatility and low exposure to factor sensitivities, Mr. Diedrich said.

"Really good net returns" are a big reason why institutions are looking at the firms, Mr. Diedrich said, but many are deterred by the "very expensive" fees.

Management fees tend to start at 3% and performance fees at 30%, but both often are higher, Mr. Diedrich said.

But the real stinger, he said, are the pass-through costs most multimanager hedge funds charge investors to cover the expenses of the fund, including salaries, performance bonuses, trading fees, technology and myriad other expenses. Mr. Diedrich said pass-through fees start at about 8% and can be considerably higher.

These fees are a big reason why institutional investors have stayed away from multimanager firms, other sources said.

Indefi's Mr. Celeghin agreed, saying multimanager firms have far fewer pension fund investors, especially public plans, despite efforts to attract them. Instead, they tend to be more popular with high-net-worth and ultra-high-net-worth investors, big family offices, endowments, foundations and sovereign wealth funds, he said.

The cost of investing with multimanager hedge funds is not a minor issue for hedge fund allocators, said Michael G. Jacobellis, partner and CIO at New York-based New Holland Capital LLC, which invests in hedge funds and credit-oriented solutions strategies.

"We've avoided investing with large managers (when) we can't negotiate fees," Mr. Jacobellis said in an interview, noting that most of the multimanager firms are closed to new investors due to capacity constraints, and "all of the good ones" charge too much.

That said, New Holland occasionally has invested in co-investments offered by multimanager firms, he said.

In 2006, New Holland spun out of APG Asset Management, the asset manager for the €523 billion ($621 billion) Stichting Pensioenfonds ABP, Heerlen, Netherlands, and continued to exclusively manage assets for the pension fund.

In 2020, New Holland moved to a multiclient model and now manages assets on a discretionary or advisory basis for two other Dutch pension funds and one U.S. fund, which Mr. Jacobellis declined to identify.

New Holland Capital managed $21 billion in hedge funds as of July 31.

Capacity constraints are an irritating problem for multimanager hedge funds, said Partners Capital's Mr. Diedrich. "All of these firms would be much larger than they already are" if it weren't for their inability to invest more given market conditions or the type of strategies they run, especially more illiquid investments.

"There is tension over multimanagers being closed to new investors as well as for fees. Half of the world is allocating to hedge funds and they want to pick the best managers, most of which are capacity constrained. The other half want the best managers but don't want to pay the fees," said Kenneth J. Heinz, president of specialist hedge fund data provider HFR Inc., Chicago, in an interview.

By way of coping with capacity constraints, multimanager hedge funds are upping the ante by tightening liquidity for quarterly redemptions so it will take between three to five years to get out of one of these funds, Mr. Diedrich said.

Verition Fund Management LLC, Greenwich, Conn., for example, recently reopened its multimanager fund to new investors, but it is in a share class that allows redemption of only 8.33% of their assets each quarter, down from 25% in the original fund, according to an investor document Bloomberg obtained.

The new redemption restriction means that investors will have to wait three years to get all their investment back.

Verition's 65 trading teams manage a collective $4.2 billion.

Millennium Management, which has more than 265 investment teams, launched a share class in 2018 that permitted 5% quarterly redemptions, down from 25% for the firm's legacy share classes, said the company's Feb. 4 investor letter, part of which was obtained by P&I.

In the letter, Millennium said the reason for the smaller quarterly redemption limit was to "better align the long-term outlook of our investors with our own to the extent possible … with longer-dated capital, we are well-positioned to weather short-term disruptions and maintain flexibility to invest in our business."

Schonfeld Strategic Advisors is seeing interest and inflows this year and remains capacity sensitive when it comes to "growing and building the business. We need to be careful with how much we give each trader," said Ryan A. Tolkin, CEO and CIO, in an interview.

While the majority of the firm's 89 trading teams are internal employees, Mr. Tolkin said Schonfeld also partners with external hedge fund teams and provides them with capital and sometimes does "spin-ins" to hire a team of managers and also engineers "spinouts" when an internal team is ready to go it alone, albeit often with investment from their former employer.

Schonfeld's trading teams manage quantitative strategies, discretionary long/short equity and tactical trading.

"The advantage of a multimanager firm is that the parent company can manage the portfolio in all market conditions. It gives us the opportunity to be nimble in making capital shifts." Mr. Tolkin said.

Bloomberg contributed to this story.