The March market shock was bad — but it was far from the worst experience Balyasny Asset Management had ever had to endure.
The year 2018, a difficult one for the stock market and hedge funds overall, proved to be the toughest in the Chicago hedge fund firm’s then 18-year history, with its funds posting deeper losses than those of its peers and investors yanking billions out of the firm. The firm’s flagship Atlas Enhanced fund lost 7 percent, and assets plummeted by half, from $12 billion to $6 billion.
When the firm was at its low, founder Dmitry Balyasny sent an email — with the subject line “Adapt or Die” — to his staff, bluntly stating that the firm’s performance “sucks” and that, to his consternation, he didn’t feel a “palpable sense of urgency” when he roamed the firm’s trading floors.
Unfortunately for Balyasny, that email wound up in the hands of Ken Griffin, the founder of rival hedge fund firm Citadel. Griffin projected the email on a screen at an internal town hall meeting for employees, telling them that this was what could happen when a firm has a poor culture, according to a Business Insider report at the time.
Faced with the investor exodus and confronting the greatest challenge of his otherwise successful career as a trader and entrepreneur, Balyasny had to make tough choices. First, he cut 125 jobs, some 20 percent of the hedge fund’s workforce. It was an especially painful move for Balyasny, whose firm previously had never had a down year of consequence and who prides himself on a family-style corporate culture.
“I’ve been doing this for 20 years and as a trader long before that — if you’re in the markets long enough, you’re gonna have some hard years,” says Balyasny, the firm’s genial and soft-spoken founder, in an interview with Institutional Investor held at the hedge fund’s New York outpost in late January.
Then came an even tougher task: revamping the firm’s entire investment process. Balyasny hired 90 new portfolio managers and analysts, a new global head of equities — Jeff Runnfeldt, who had formerly held a similar role at Citadel — and a new chief risk officer, whom he tasked with overhauling the firm’s entire approach to risk management.
Now, with the global coronavirus pandemic wreaking havoc on global markets in 2020 — smashing worst-ever records for quarterly stock market performance and job losses alike — Balyasny’s fancy new risk systems are getting the ultimate test.
“With the amount of volatility you are seeing in the book, they have a lot of opportunity to generate alpha,” says Tim Barrett, chief investment officer at Texas Tech University. “These guys, theoretically, should be killing it.”
That’s exactly what they’re doing, as it turns out.
In a quarter when the Dow Jones Industrial Average lost 23 percent, the Standard & Poor’s 500 lost 20 percent, and the average hedge fund lost more than 8 percent, Balyasny’s Atlas Enhanced fund racked up a 4.66 percent gain. The fund is now up close to 8 percent through the third week of April, according to people familiar with the performance. That follows a 12 percent gain in 2019, with negative correlation to the S&P 500. In institutional investment language, that means the firm’s returns had less than nothing to do with how the stock market performed in 2019 — providing the elusive alpha generation that such investors crave.
“So far they are doing great,” says Barrett. “The changes they made at head of equities and risk [were] perfectly implemented.”
David Holmgren, chief investment officer of Hartford HealthCare and a longtime Balyasny investor, concurs. “I’m just absolutely so pleased with what they are delivering for us,” he says. “We got the performance, and more importantly, we got what we needed, which is protection in the sell-off.”
The run of performance was particularly well timed, as Balyasny told investors at the end of 2019 that it plans to open up to new capital for the first time in years. The kinds of clients it will likely attract reflect another transformation the firm has undergone in recent years, having evolved from a scrappy startup hedge fund with roots in day-trading to a more sophisticated global asset manager — albeit one that is still mentioned in the same breath as its larger competitor across town.
“I hear of it as a mini Citadel. That’s a common analogy,” says Holmgren, who feels that Balyasny simply took longer to get to the growing-pains stage that hit its larger peers a decade ago.
“Dmitry had not been around as long, or [been] as famous, during ’08 — when he actually made money — as some of the larger firms, the ones that had a really bad ’08 and that’s when they grew up and did their layoffs,” he notes. “I saw [2018] not as bad performance and layoffs — for me it was when they went through the experience that the other famous hedge fund managers went through exactly a decade earlier. They grew up.”
Balyasny comes by his fandom honestly. Born in Kiev, his family immigrated to the United States when he was seven, after the Soviet Union lifted restrictions on Jewish emigration. His parents settled in Chicago, speaking no English. His mother had been an engineer and his father a professor, but in Illinois she cleaned hotel rooms and he worked odd jobs.
At age 12, Balyasny began doing sales door-to-door; as a teen he became interested in the stock market and started trading. He got licensed as a stockbroker and got a job at a tiny firm — “dialing for dollars,” as he puts it — while earning a bachelor’s degree in finance at Loyola University in Chicago.
“I was losing everything I made in commissions trading for myself,” he recalls. “But I had a passion for investing, and I was determined to figure it out.”
He applied for work at every hedge fund he could think of. After amassing a pile of rejection letters, he finally got a job at Schonfeld Securities, in 1994.
“They wanted people with no preconceived notions of what they were doing — so that was a good fit for both sides,” he says, laughing.
The job provided the ultimate eat-what-you-kill training: Traders were provided with a little bit of capital and lunch every day, but no base salary. Balyasny made no money the first year, but he learned from the more experienced traders he worked with and earned profits consistently after that. He did well throughout the ‘90s, building up his capital base and building out a team internally, which he spun into a separate division that launched its own fund. That team became the foundation of what would ultimately be Balyasny Asset Management.
“The philosophy was the same: We wanted to generate uncorrelated returns through lots of P&L streams,” says Balyasny. “The real value of a platform is specialization. The firms that stood the test of time were the ones that built real businesses” that were not tied to any one person or strategy, he explains. “Having lots of exposures in different spaces seemed much more sustainable.”
In 1999, Balyasny hired Scott Schroeder, who had trained as a lawyer, to join his team within Schonfeld, and later brought on Taylor O’Malley, who had previously worked as an investment consultant and corporate executive. The two men were the first business hires Balyasny made, and the trio became the founding partners of BAM.
“I always knew I’d work for someone younger than me — I just didn’t realize it would happen when I was 30,” jokes Schroeder about Balyasny in an interview at the firm’s striking new Chicago headquarters in late February. “There was very little known about hedge funds in ’99. I wasn’t equipped to judge his trading prowess at that point — but his ability to lay out his vision at 29 was as good as the Fortune 500 CEOs I’d seen in boardrooms.”
The firm formally launched as an independent entity in 2001, trading mostly long-short equity — which still accounts for 70 percent of the firm’s risk — with several sector specialties and a global tilt. Later the fund added global macro, credit long-short, and other strategies.
The firm had a remarkable run, rarely losing money during the first 16 years of its existence and delivering an annualized return of 12 percent. Assets swelled to $12 billion on the back of strong performance during turbulent times in the markets, with the firm posting gains throughout the dotcom crash and the financial crisis of 2008.
But 2018 was a different story.
“We had done a very good job making money through the tough periods,” says Balyasny, but “2018 was a challenging year for us for a variety of reasons. What went wrong? A difficult market, coupled with things that we could have done better. It was a bad year for long-short equity, and that’s 70, 75 percent of our risk.”
Balyasny acknowledges that the firm had grown too rapidly, “so our ability to be in the weeds with every team had been stretched.” The hedge fund had also realized that it needed to update its risk management practices. “We were in the process of making improvements and hadn’t implemented everything when we ran into the buzz saw of the environment for long-short equity,” he says.
“Part of the problem is we had gotten too big too fast,” Schroeder agrees. “The three of us went from $20 million and 12 people to $12 billion and 600 people. There was overexpectation on existing teams’ ability to generate alpha on the scale we needed for $12 billion. At the same time, alpha was decaying at a really fast rate. We didn’t recognize that fast enough. And we didn’t have analyst infrastructure to support PMs who needed idea velocity to support a $12 billion asset base.”
Finally, the team’s approach to risk was too conservative, in its own estimation.
“Historically, our best defense was to take risk down,” Schroeder notes, citing 2008 as an example. “[In] 2008 — we played defense, we took capital down, we made money. In ’09 our problem was we didn’t shift to offense. We didn’t have the infrastructure in place to start exploiting it fast enough to make money again.” In other words, though the firm ultimately made money in 2009, it could have made more if it had deployed more capital earlier.
The firm knew it needed to make big changes. So in late 2018 it hired Alex Lurye.
Lurye, who had been the chief risk officer and head of global portfolio construction at Citadel, brought a fresh set of eyes to the firm’s risk management approach.
“When I joined and looked at things holistically — risk management was viewed as a loss mitigation technique, as opposed to being a backbone to an alpha-generation process,” he says.
His first order of business was to integrate risk management into the portfolio management process. That led to the introduction of a volatility target model, which enabled the firm to use risk management as an alpha-generation tool, rather than just as a defensive measure, he claims.
Schroeder gives a simple example of how the model works: A biotechnology stock and a financial stock might have the same return potential, but the financial stock might have three times the volatility. With a volatility limit on each trade, it is still possible to invest in the financial stock, but you need to neutralize the volatility factor, perhaps by having a competing short position. “It’s the opposite of what you have in a gross-exposure-management strategy,” Schroeder says.
Lurye says the firm also beefed up both the quality and the quantity of its investment ideas by making new hires on the portfolio management and analyst teams, which allowed the firm to double the amount of effective ideas over the course of the year — what it terms “idea velocity.” The firm also runs close to 100 different stress tests, including those based on historical events, as well as what-if scenarios.
This risk overhaul was one of the primary factors that led one institutional investor to take the leap and invest with BAM last year, after having had the firm on its watch list for several years.
“We were impressed with the turnaround story that they operated there,” says this person, who asked not to be named. “The risk management — which we believe is key to a multistrategy fund — and the ability to switch from strategy to strategy and shut down strategies that aren’t performing [seem] to work very well.”
Lurye credits his bosses, and what he describes as the firm’s entrepreneurial culture, with giving him free rein to make changes. “For BAM to adapt the framework — it says a lot about the firm,” he says. “Last year’s performance was not an accident. It’s the result of hard work and implementing those changes.”
For his part, Texas Tech CIO Barrett, though happy with the results post-2018, is more cautious in judging whether switching to a new risk framework was the right move.
“I think moving to the volatility framework that they did is very challenging, because volatility is by itself a tough indicator,” he says. “You will know a lot more in April and May, looking backwards, how that framework really paid off. But it seems to be working.”
Schroeder explains, in a phone conversation in mid-March, that the firm’s performance in March didn’t come from a simple bet against the S&P 500.
“The most important thing has been that we really came into this with a diversified portfolio,” he says. “And as we started to see some data points that suggested there was complete complacency and little respect for the impact of a [pandemic] of this size, we didn’t make a huge bet on the virus per se, but what we did do is further tighten our factor and risk exposures so we were in a neutral position to take advantage of potential dislocation rather than make a directional bet.”
He says that was the direct result of the changes implemented in the firm’s recent overhaul.
“Before you can recognize a dislocation, you have to put yourself in a position where you can’t get knocked out by an event,” Schroeder points out. “Right away we did a lot of work to reduce crowding as a part of the risk management. In this instance, it’s both hedge fund crowding and a function of the quant unwind,” or computer-based trading strategies indiscriminately dumping stocks in the sell-off. “If we position ourselves so that we are not as exposed to that crowding factor, then we are still standing. That’s different than saying we should just short the S&P. That’s a directional bet, and that isn’t what we are paid to do.”
He adds that the firm also reduced its exposure to the momentum factor as well as its correlation to market moves. Perhaps most satisfying to the principals, however, is the fact that the hedge fund deftly navigated the first real test of its revamped investment process. “We have been able to maintain our performance and manage through this period and outperform — without having to change the DNA or the construct of the firm to do it,” Schroeder notes. “We didn’t have to suddenly become a beta player or virus expert to make a bet on this.”
Balyasny’s performance during the market turbulence this year is exactly what many institutional investors say they are looking for.
“If you are a large plan [that] has an allocation for the purposes of volatility offset but you’re still looking for a return, then I rate them extremely high,” says Holmgren of Hartford HealthCare. “If you are looking for high beta correlation to the market — which Balyasny is so not; their correlation is like 0.1, 0.2 — then they are not what you are looking for. I rate them very highly, but specific to what we do.”
It’s a far cry from the firm’s early days as a day-trading shop. Schroeder talks about the firm’s growth trajectory as having three phases.
“In the day-trading days it was like running a casino. In the middle years it was like running a sports franchise. Now you are running a business. Expenses, costs become important,” he says. “Investor sophistication has changed too. Then, everyone published monthly numbers. Now there is daily transparency — the sophistication of investors is so much better. They care about risk management more, and they get it.”
As part of that transformation, the firm’s investor base transitioned from wealthy individuals to funds of hedge funds to primarily institutional investors, including pension funds, sovereign wealth funds, corporate pensions, and so on.
The firm also hit a few bumps along the road. A statistical arbitrage strategy was shuttered, as was a best-ideas fund. And several of the principals said that though they are pleased with recent performance, they aren’t ready to take victory laps. Yet the firm is opening to new clients for the first time in four years, and whatever happens next, Balyasny says he remains focused on enhancing the business and maintaining a culture “where people want to come to work and be a part of something.”
And he is proud of that culture — a certain rival firm’s commentary notwithstanding. Balyasny wouldn’t be drawn in when asked about Griffin’s sharing of Balyasny’s companywide email as a blueprint of what not to do.
“I have great respect for the business they have built,” he said. “I’m not going to comment on what they might or might not have [said]. I’m going to focus on my firm.”
