The rich get richer while the rest of us fall further behind.
If that sounds like a complaint about income inequality from Alexandria Ocasio-Cortez, it’s not. Rather, it is a description of hedge fund managers – those once “Masters of the Universe” who except for a small minority, are not having an especially good year.
Lopsided distribution of gains is nothing new. In their 1995 best seller “The Winner Take All Society,” professors Philip Cook and Robert Frank (MIB here) explain why so much of society’s economic rewards rise to the top of every field.1 Sports, entertainment, and especially asset management, all see a “fat head, long tail” distribution of gains. Most of the winnings go to a handful of superstars, be they LeBron James, Ariana Grande or Jim Simons.
When The Winner Take All Society was first published, “the pay of a typical chief executive of a large American company was 120 times that of a manufacturing worker, compared to a mere 35 times in 1974.” In the 1950s, it was 20 times. The top one percent of U.S. earners were capturing more than 40 percent of the country’s earnings growth in 1995. According to the authors, that shift that had never occurred “without a revolution or military defeat” before.
Today, the ratio of workers to chief executive salaries is 361 times.
More of the economic pie is being captured by the very top tier. This is also true within the hedge fund industry. They are the latest group to succumb to “Winner Take All” ethos. Despite the challenging one-two punch of fee compression and weak performance, a segment at the top of the industry continues to capture nearly all of the gains. The rest of the alternative space faces the same competitive pressures everyone else does, albeit from a much nicer zip code.
In 2018 “the industry saw its biggest annual loss since 2011, declining 4.1 percent on an a fund-weighted basis,” according to a Bloomberg News report. And Institutional Investor noted investors pulled a net “$6.5 billion from macro hedge funds in the first quarter” of this year (2019), as “compared with $12.3 billion outflows” for all of 2018.
For all but the most elite hedge funds, poor performance has led to pressure from clients. Look no further than the changing nature of those fees. The infamous “2 & 20” – a 2 percent fee on the assets under management plus 20 percent of the net gains – now averages ~1.45% percent and ~16.9% respectively. The Financial Times, citing a Credit Suisse report, notes that only 3% of hedge funds even charge a 2% management fee anymore, while only 16% take a fifth of profits.
With a few notable exceptions, 2 & 20 is no more.
About those exceptions: the winner takes all ethos applies as much to hedge fund managers as it does to the rest of us. While most funds are struggling, a few have had outstanding year(s) that justify higher fees. Bridgewater, with $160 billion, saw its flagship Pure Alpha vehicle generate 14.6 percent in gains in 2018, even as the U.S. markets fell more than 5 percent and the rest of the world’s bourses mostly did much worse. Pure Alpha has garnered annualized returns of 12 percent since inception in December 1991.
D.E. Shaw, with more than $50 billion in assets, is raising its fees for 2020, moving back to a fee structure of 3 percent of assets and 30 percent of profits it used throughout the aughts. Its $14 billion Composite fund, gained 11.2 percent in 2018, and is closed to new investors. It was previously charging 2.5 percent management fee and 25 percent incentive fee. That’s rarified air to begin with, and new higher fees puts it in fairly elite company.
But 3-and-30 is not the new 2-and-20.
A small percentage of firms are capturing client dollars, mind share, and of course fees. If you are fortunate enough to have capital in one of a few 100 hedge funds that are consistently putting up outstanding numbers, consider yourself lucky. The rest of the industry is suffering the effects of high expenses and poor performance, with increasing capital departures.
Money goes to where it is treated best. For much of the hedge fund industry, this adage only means more bad news to come . . .
1. Not to be confused with the current best seller “Winners Take All: The Elite Charade of Changing the World” by Anand Giridharadas
Hedge Funds Bear the Blame for Looking Bad (June 1, 2018)
Paying Alpha Prices for Beta (May 9, 2018)
Death of Hedge Funds Have Been Greatly Exaggerated (June 21, 2017)