Markets

Nir Kaissar is a Bloomberg Gadfly columnist covering the markets. He is the founder of Unison Advisors, an asset management firm. He has worked as a lawyer at Sullivan & Cromwell and a consultant at Ernst & Young.

Don’t call it a comeback just yet.

As Bloomberg News reported on Tuesday, hedge fund manager Steven A. Cohen is preparing to raise as much as $10 billion from outside investors in 2018 for a new fund. Combined with his personal fortune of $11 billion, the fund could oversee more than $20 billion, which would make it the largest U.S. hedge fund launch in history.

Do It Again
Steven Cohen is contemplating the largest U.S. hedge fund launch in history
Sources: Bloomberg, Wall Street Journal

It would also mark an extraordinary turnaround for Cohen. Just four years ago, he made history in all the wrong ways. His hedge fund firm at the time, SAC Capital Advisors LP, was charged with insider trading. The firm pleaded guilty and paid a record $1.8 billion penalty.

In addition, six current or former SAC employees were convicted of various criminal charges related to insider trading. Cohen was never charged with insider trading, but the Securities and Exchange Commission did accuse him of failing to supervise misbehaving employees. In the ensuing settlement, Cohen agreed not to manage outside money until Jan. 1, 2018.

Theories abound about why Cohen would want to get back in the game of managing other peoples’ money, ranging from ego to boredom. And in the end, he may not go through with it. 

Cohen clearly doesn’t need the money. Sure, it would be nice to have outside investors help pay for his 1,000-employee family office, Point72 Asset Management LP. But the profits on his personal investments should more than cover those expenses.

Maybe, as Fortune writer Jen Wieczner put it, “Steve Cohen wants people to believe that he never did anything wrong. So how does he prove that? Well, if he can deliver the highest returns -- at least as high as he always has -- while he literally has people from the government, including a government appointed compliance monitor, in his office, then people are going to believe that he really is just that good.”

But trying to recreate the SAC magic with $20 billion would be a huge gamble. If Cohen falls short, it would only reinforce the suspicions he might be trying to dispel. And generating outsize returns with that much money won’t be easy.   

Hedge funds generally don’t disclose their performance to the public, but Frontline published a chart in 2014 showing SAC’s annual returns from 1992 to 2012. Using that chart, I estimated the performance of SAC Capital Management LP -- SAC’s fund for U.S. investors -- during that period.

The fund’s performance over the entire period was spectacular. SAC tripled the return of the broad market with comparable risk. The fund returned roughly 26 percent annually over those 21 years with a standard deviation of 22 percent. Over the same time, the S&P 500 returned just 8 percent annually, including dividends, with a standard deviation of 19 percent. (Standard deviation reflects the performance volatility of an investment; a lower standard deviation indicates a less bumpy ride.)

Bigger Not Better
As SAC grew from $25 million in 1992 to $16 billion at its peak, outsized returns became harder to generate
Sources: Frontline, author's calculations

There’s a critical detail in the numbers, however. Cohen launched SAC in 1992 with $25 million. Over the next 10 years, the fund returned roughly 43 percent annually, or 30 percentage points annually better than the S&P 500.

Then investors piled in. The firm eventually ballooned to $16 billion, and sustaining those monster returns became ever more difficult along the way. Over the 10 years that ended in 2012, the fund returned roughly 12 percent annually, or 5 percentage points annually better than the S&P 500.

It’s not just SAC. According to Hedge Fund Research Inc., hedge funds managed $100 billion in 1992. Over the next 10 years, the HFRI Fund Weighted Composite Index returned 15 percent annually. By 2012, hedge funds were managing $2.3 trillion, and the returns over the previous 10 years shrunk to 7 percent annually.

Size Kills
As the hedge fund industry has grown, returns have shrunk
Source: Bloomberg

It’s a recurring theme in finance: Size kills. There’s a reason why one of the best-performing hedge funds of all time, Renaissance Technologies’ Medallion Fund, obsessively caps its capacity at $10 billion. And yet it’s a lesson that both managers and investors routinely fail to heed.

It's one that Cohen can't ignore as he decides whether he wants to try to reconjure the magic.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Nir Kaissar in New York at nkaissar1@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net