Hedge Fund Industry Growth ‘Unwelcome,’ Says Caxton’s Lawby
Says business has grown too big to deliver outsize returns
Funds weren’t created for managers to ‘live well’ on fees
Andrew Law said the hedge fund business is too big -- and failing.
Law, who runs Caxton Associates, said the growth in industry assets since the global financial crisis has been “both an exceptional and unwelcome development.” Managers now need to generate gains of $350 billion a year to satisfy investor expectations, he said. That’s an annual return of about 12 percent from the $2.9 trillion industry, which has returned an average of 2.2 percent in the past five years.
“Against a backdrop of comparatively sclerotic growth, S&P 500 valuations stretched on numerous metrics, and alongside approximately $10 trillion of negative-yielding debt, it is reasonable to conclude that the alternatives industry is inappropriately sized to deliver on clients’ return expectations,” Law, 50, said in an investor letter Tuesday obtained by Bloomberg News.
Law is joining money managers including Peter Kraus at AllianceBernstein in urging the industry to scale back assets to improve performance. Most active money managers, and hedge funds managers in particular, have trailed the broader stock market for years, prompting clients to push for lower fees or flee to low-cost index products.
New Share Class
Caxton, one of the most expensive hedge funds, said in its letter that it would lower its annual management fee to between 2.2 percent to 2.5 percent. It previously charged as much as 2.6 percent, according to a government filing. The firm will continue to take a 27.5 percent cut of profits.
Caxton, based in New York, also introduced a new share class that locks up client money for three years and charges a 2 percent management fee, according to the letter. All the changes take effect in January. Law didn’t return an e-mail seeking further comment.
The changes follow similar moves by veteran managers including Paul Tudor Jones and Dan Och. High expenses have been bedrock of the hedge fund businesses, enriching managers as industry assets doubled in size since 2008. Now investors are pressing for relief.
Even with Caxton’s cuts, its fees remain above the standard industry rate of 2 percent of assets and 20 percent of profits, an expense structure that many managers have stubbornly refused to change even as their performance trailed. Warren Buffett has described the fees as “a compensation scheme that is unbelievable,” and Bill Gross of Janus Capital Group Inc. called them a “giant ripoff.”
Living Too Well?
“The hedge fund industry was not created for managers to live well on management fee surpluses, but rather to strive for strong and differentiated performance,” Law said. “Whilst it is entirely appropriate that the rewards for great performance continue to be exactly that, it is important to recognize that compensation across the entire financial services industry has moved lower post-global financial crisis.”
Caxton had $11 billion in regulatory assets, which includes borrowed money, according to a government filing. Law said in the letter that controlling asset size is key to delivering returns.
Kraus, CEO of AllianceBernstein Holding, said in June that “it’s pretty clear that active managers have not performed above their benchmarks to any great degree.” He estimated assets in actively managed funds may have to shrink by as much as 30 percent to restore their ability to beat indexes.
Caxton, which was started in 1983, was one of the first macro funds that seek to profit from macroeconomic trends by trading everything from bonds. It lost 2.6 percent this year through Sept. 2 after posting a 3.5 percent gain in 2015 and a loss of 1.4 percent the previous year, according to an investor document.
The average macro hedge fund has returned 1.6 percent this year through August after losing 0.14 percent in 2015 and 2.2. percent in 2014, Bloomberg data show.
Caxton was started by billionaire Bruce Kovner, who ceded control of his firm to Law four years ago. Law, who grew up in Cheshire, England, and earned an undergraduate degree in economics at the University of Sheffield, joined Caxton in 2003.