When economic historians look back through the annals of the 2020s, one thing is likely to stand out in the financial services industry: multistrategy hedge funds. Their growth; their growth; their razzle; their pay.
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But after a decade of hoovering up whoever has a Sharpe ratio of 1.5 and can deploy $25m in capital (or preferably a Sharpe ratio >3 who can deploy $100m) and paying them ~ 20% of PnL, multistrategy hedge funds are falling out of favour. Cuts have been deeper than usual; rates traders have been returning to banks. The older hedge fund dogs feel vindicated, and they’re telling us so.
“I was at a dinner last night with the CEO of a hedge and the former COO of one of the major multistrats, who was there for over a decade, and we were all in our 50s,” says one senior equities portfolio manager who’s been in the game for over 30 years. “We were discussing the state of asset allocation and the talent that’s coming through the industry, most of which knows very little about how portfolio management is really done.”
Multistrategy funds are intended to be market neutral. Different teams run different strategies under portfolio managers in so-called “pods,” but instead of cancelling each other out, in combination they generate alpha. At some funds, one pod often won’t know what the other pods are doing. They make money by beating the market on average. “By the law of large numbers, they tend to have better and better risk adjusted profiles,” Giuseppe Paleologo, quant and former risk manager at top funds like Millennium, told Bloomberg in reference to the multistrats, speaking last month.
It’s precisely because of this, though, that detractors say “pod shop” portfolio managers don’t know how to manage money across the cycle: risk is managed centrally at the organization level; trades are hedged extrinsically by the unseen strategies of other pods rather than by individual portfolio managers. “I have friends at one of the big pod shops and the moment they put a position on, there will be two central hedges against it,” says the veteran portfolio manager. “But when I put a position on at my fund, I will hedge against it myself.”
In this way, he argues that hedge fund talent is being hollowed-out by the pod shops. “The industry is full of kids aged 25-35 who are used to operating within $30m sleeves, with tight stops when they’re down 2.5%. There’s a generation of people who know almost nothing about generating alpha with their own long and short trades. “
The pressure to keep generating risk-free returns is the key limiter on the experience of portfolio managers at the multistrategy shops. In theory, these big funds can be lenient about losses that might come good in time. In reality, they’re often not, especially with unproven talent. “The amount that you’re allowed to lose is usually very, very limited and so your time horizon for trades needs to be short,” says another seasoned portfolio manager. “They might say the drawdown [loss] is 5%, but they’ll usually take capital away when you’re down 2.5% to 3%. At that point, you’ll already have one foot out the door.”
This means that a trade idea that loses 10% in the short term, but that makes 40% in the long term, is no good for a multistrategy fund. Nor is a trade idea that will make 40% in the long term but that can only be implemented in six months’ time if a loss is to be avoided. “The big pod shops want you to run 65%-70% of your risk budget every single day,” says the other trading veteran. They want you to put capital to work even when the opportunity set isn’t very large, but compelling opportunities can’t always be found, and they don’t like that.”
The upshot is that only a few trading strategies work at the big hedge funds and that many portfolio managers don’t last. “20% of PMs more or less are let go or leave every year,” said Paleogo in his Bloomberg interview. Even this might be generous: departures within a few months are not unusual.
Some of the PMs who don’t last go back into banking; many go on to repeat the experience at other multistrategy hedge funds. “It’s a constant revolving door,” says the equities manager. “- You see the same people recycled six or seven times at different funds.” In each of them, they have no experience of being down more than 5%.
Before the multimanagers, it wasn’t like this. It still isn’t like this at single manager funds: Chris Rokos was down 26% in 2021, but up more than 50% in 2022. The hedge fund veterans argue that it’s this ability to place bets and hedge them over time that will count in the future. “It will go back to knowing the asset instead of scraping data and putting on an arbitrage trade that lasts 45 minutes,” says one. ‘The new generation, who only want to work for the multimanagers, have very little experience of this.”
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