In Hedge Fund `Killing Field,' Smoldering Fears Catch Fire

  • Losses at some funds are more than during the financial crisis
  • Loeb sees `first innings of a washout' in the industry

Dan Loeb has seen plenty of market turbulence since he started his hedge fund more than two decades ago in the weight room of a fellow money manager: the Asian currency collapse, the Russian debt default, the bursting of the Internet bubble and the global financial crisis. 

It’s the last few months that have him amazed at the chaos in the industry.

“There is no doubt that we are in the first innings of a washout in hedge funds and certain strategies,” he wrote in a quarterly letter to investors in his New York-based Third Point. Investors have seen “one of the most catastrophic periods of hedge fund performance that we can remember since the inception of this fund.”

Loeb, an outspoken manager who has taken on investors Warren Buffett and Bill Ackman, as well as the Obama administration on various occasions, is putting his finger on a sore spot for his profession. Hedge fund managers, who charge hefty fees to protect investors from losses and make money in market volatility, have instead amplified swings in past months. If Loeb’s right, a lot of funds aren’t going to survive.

“We have had these fears and these signs before, 2003 and 2009," said Jacob Schmidt, chief executive officer of Schmidt Research Partners, a London-based investment advisory firm. “Now we are at the new crossroad. The industry will not disappear but I think it is going to be very hard.”

In aggregate, the $2.9 trillion industry is having its worst start to a year in terms of performance and client withdrawals since 2009, when global markets were reeling from the most severe financial crisis since the Great Depression. 

Odey’s Battlefield

Managers such as Crispin Odey, Ackman and John Paulson posted declines of at least 15 percent in the first three months in some of their funds -- returns that would be considered horrific for an entire year -- while Alan Howard and Paul Tudor Jones are bracing for billions of dollars fleeing their firms.

Odey, who founded his London hedge fund firm just a few years before Loeb, described markets in mid-March, when his portfolio was rising and falling by more than 5 percent a day, as a “battlefield.”

Barry Wittlin, a former top proprietary trader at Merrill Lynch & Co., told clients in a letter dated April 27 that he’s shutting down his firm after nine years, without giving a reason.

The troubles for these billionaire and multimillionaire money managers, singled out already by U.S. presidential hopefuls as the poster children of greed, may be more acute this time around, perhaps because the whole world isn’t falling apart with them. Savers who had stayed invested in a low-cost index fund tracking the U.S. stock market would have made about 3 percent this year, or almost 10 percent annualized.

‘Consensus View’

So why did the smartest and best-paid money managers fare so poorly? Loeb painted a picture of a handful of crowded trades that got many of the top investors in this trouble. Investors, he wrote, were caught “offsides” on multiple occasions ever since China’s surprise currency devaluation roiled markets in August. Wagers against the yuan and investments in technology companies including Netflix Inc. and Amazon.com Inc., as well as drugmakers including Valeant Pharmaceuticals International Inc., hurt managers, he said.

Part of the problem has been managers thinking they could and should go up against a central bank, Loeb’s firm included. Third Point said that it was among the hedge funds that piled into bets against the yuan, materials and companies that were affected by a slowdown in Chinese growth.

“By early this year, the consensus view that China was on the brink and investors should ‘brace for impact’ was set in stone,” Loeb said in the letter. Investors believed in February that the Chinese government had no choice but to devalue its currency to maintain economic growth and take necessary write downs on some $25 trillion of state-owned enterprise debt.

Citadel, Senfina

Loeb said he cut losses when his firm realized in mid-February that China was unwilling to devalue its currency and was instead signaling fiscal stimulus. His fund ended up preserving most client money with a loss of 2.3 percent for the quarter, a performance Loeb said would allow it to take advantage of the dislocation in the industry.

The China fiasco was quickly followed by problems at large multistrategy firms like Ken Griffin’s Citadel, which had lost 8 percent in its main fund through mid-March. These funds typically farm out cash to dozens of individual teams, keeping their bets on rising shares more or less equal to those on falling stocks, and are quick to cut losses. Senfina, the multimanager fund run by Blackstone Group LP, slid 17 percent in February, erasing much of its 2015 gain. Izzy Englander’s $34 billion Millennium Management fell 2.7 percent in February, its third-worst month ever.

“Unfortunately, many managers lost sight of the fact that low net does not mean low risk and so, when positioning reversed, market neutral became a hedge fund killing field,” Loeb wrote.

Pulling Cash

Hedge funds on average lost 0.6 percent in the first quarter, according to data compiled by Bloomberg, the poorest start to a year since 2009. Clients pulled a net $16.6 billion in the last two quarters, the most since 2009, according to Hedge Fund Research Inc. In 2015, 979 funds closed, more than any year since 2009, the research firm said.

Chase Coleman, whose performance has put him atop annual lists of the best-performing hedge fund managers, lost about 22 percent in the first quarter by holding some of the same companies that have made him money for so long. His Tiger Global Management hedge fund’s biggest U.S. holdings at the end of last year were Amazon.com Inc. and Netflix Inc, which dropped more than 10 percent in the first three months.

Investments in health care were a widow maker for one of the biggest names in the hedge fund industry. Ackman’s activist hedge fund Pershing Square Capital Management lost 25.6 percent in the first quarter driven by losses in its investment in Valeant.

Some investors lost patience with hedge funds. New York City’s pension for civil employees this month voted to pull $1.5 billion from hedge funds because of high fees. Howard’s $22 billion Brevan Howard Asset Management was among the casualties.

After years of lackluster returns, investors asked to withdraw about $1.4 billion from Brevan, while clients of Jones’ Tudor Investment Corp. are seeking to pull more than $1 billion, people with knowledge of the matter said this month.

Although Loeb said he sees opportunities to make money, he says the “increased complexity” in markets over the past few months is here to stay.

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