Fortress is creating a Multi- Strat fund too?
I was happy for Katie, but couldn’t help thinking ‘Does the world really need another Multi-Strat hedge fund?’
Is there a limit to these things, or does Fortress go and do the same thing; hire 100 traders in an assortment of strategies, manage the risk, market it as ‘7-8% with low volatility’, and raise $20 billion from US pension funds?
Probably.
But are Multi-Strats really that good?
Or is Fortress ringing the bell on peak Multi-Strat?
I wanted to dig further into hedge fund returns and the idea of ‘Peak Multi-Strat’, but needed data and help. I needed someone who really new the numbers and the statistics for the different strategies. So I reached out to Elisabetta and Alessandra at Hedge Invest, the two smartest sisters in the business. After 25 years of managing hedge fund investments and collecting the data, they’ve seen it all. I also love their non-consensus views. It keeps me in check.
Hedge Invest put me in touch with their very own Dr. Maurizio Malvasi. ‘Dr’ because he wrote a Phd on hedge fund returns and hedge fund index creation. Seriously.
So for 2 weeks Maurizio and I went down the rabbit hole of random sample portfolios vs. index returns, fund return dispersion, drawdown correlation and charts of rolling 12 month Kurtosis.
I’ll get to my top 10 takeaways, but first grab yourself a coffee. I made you a Hedge Fund chart book with 60 slides of hedge fund info about 10 and 20 year returns by strategy, sub-strategy, Sharpe Ratios, correlation, fund flows, etc.
YWR Hedge Fund Chart Book
My 10 Hedge Fund Takeaways.
Is it 8%/year or is it 5%? Eureka vs. the Rest. Maurizio and I reviewed 4 different hedge fund return indices, and they all have different numbers, but it looks like the average return is more like 5%, not 8%.
How do all these different strategies have the same return?
Isn’t is surprising that these supposedly diversified strategies all deliver roughly the same return? OK, one does 3%, and one does 6%, but it’s not like one strategy does 15% annualised and the other does 4%. I was surprised how similar the returns are. Is it all the same people with the same views, just trading different things and ending up with the same return?
Variance of a random fund sample is much higher than the index. This is a really important point. Hedge funds are not like investing in the S&P 500. You don’t know what you are going to get. There is no standardisation. Nobody has the same hedge fund portfolio. So how your hedge funds perform vs. another portfolio, and how they do versus the index is a big open ended question. When Maurizio and I randomly sampled fund returns we always ended up with a lot more return volatility than the index. Basically, a way lower Sharpe.
Multi-Strat returns are skewed by large funds, which maybe you can’t own. It doesn’t seem to be a problem for any other strategy, but when it comes to Multi-Strat there is a big difference between the AUM weighted returns and the average return. This seems to be a case where bigger is better. And of course the bigger question is can you access the 3-4 funds driving these returns? What does it matter if Kensington does 30% if it is closed and you can’t invest?
Is Stat-Arb the secret sauce for Multi-Strat? Everybody loves that Multi-Strats made money through the whole 2020-2022 roller coaster. But how did they do that? Especially in 2022. That’s was especially magical. Ken and Izzy haven’t opened the kimono to tell me exactly what is going on. But the secret sauce might be Stat-Arb. Stat-Arb might be a bigger deal than we think. It was the standout quant strategy in 2022, and could be the hidden driver of in Multi-Strat returns.
Multi-Strat drawdowns are correlated. Hundreds of traders, trading a multitude of supposedly uncorrelated things with Phd risk managers monitoring the numbers on everything, but then in 2020 they ALL got smashed together. Why? What does this tell us?They must all be doing the same thing. They almost never have big drawdowns. But for some reason 2020 really got them.
Everything is correlated to equities and everything is correlated to each other. This goes back to point #2. We have all these esoteric strategies, but they all have a correlation of 60-80%. It’s all the same thing.
Only uncorrelated strategy is CTA/Quant. The high correlation of most hedge fund strategies to equities makes you wonder if you need them. Do I really need a 5% return fund that goes up and down with the S&P? Or, should I just own NASDAQ mixed in with some CTA’s, in case the world ends? Are CTA’s the only hedge fund strategy that are actually different and have a purpose?
High variance and asset weighted returns are supportive of fund of funds model. After doing the comparison of random sample portfolios with the Hedge Fund indices I have a greater appreciation for the fund of funds business. Everyone gripes about the extra fees, but this is a case where it actually is difficult to track the data on all these funds over long periods of time, know what the managers are really doing, maintain the relationships and access, and construct a highly diversified portfolio which delivers the returns you are looking for. I now realise putting a few funds together by yourself has a high level of Investment Committee risk. So I came away thinking Hedge Fund fund of funds are probably worth the money.
Does everyone need to take more risk? Do we need to launch Booster Funds? Are we at peak Multi-Strat? I don’t know. The return are great and Ken is a genius, but that assumes you can get into the top, top funds. Otherwise, you are in with the rest doing 5%.
And so I was left with the overarching view that the problem with the industry is it is not taking enough risk. HF managers all go out thinking that if they deliver low-vol returns the pension funds will give them enormous allocations, but for some reason that isn’t happening. The industry is getting net outflows year after year. Maybe the pension funds realise hedge funds are an expensive 5% return. Zero interest rates are over and now they can get 5% in cash. They don’t need to pay 2&20 with lockups for 5%.
Yes, it’s super scary, but I think if you are going to grow in this business you need to take the ‘hedge’ out of hedge funds. There are already enough ways to reduce risk. Mix cash and bonds with equities, etc. Instead, how about launching a Booster Fund? How about being a way to boost returns and risk? That might be something which is harder to do, more attractive, gets the juices going, and generates lots of fees. Maybe we need to go back to the old days of Paul Tudor Jones. And maybe the pendulum swings at the pension funds too, and they realise their liabilities are growing faster than they realise and they also want some Booster Funds for their portfolios!!
Alright, have a good weekend. The rain has finally paused in London.
And here is another one for our techno symphony collection. Tim would be happy.
The only thing I can find that is anti-correlated with equity risk is oil and gas equities. This perhaps has a cause. When oil (and natural gas) prices fall, these companies underperform but the economy effectively gets a tax cut and equities in general can do well. Conversely when oil and gas prices are high equities of O&G producers do well but it is an input cost to the economy and often causes a recession.