To say 2008 was a difficult year for Highbridge Capital Management is an exercise in understatement. The New York–based multistrategy firm, which was founded more than 17 years ago by childhood friends Glenn Dubin and Henry Swieca and is now part of J.P. Morgan Asset Management, specializes in relative-value strategies such as convertible and statistical arbitrage.
When Lehman Brothers Holdings filed for bankruptcy protection in September 2008, and the markets stopped functioning, Highbridge suffered severe losses. The firm received billions of dollars in redemption requests and was forced — reluctantly, says Dubin — to put up gates, halting the ability of investors to get back their money.
Highbridge was not alone. Almost the entire hedge fund industry experienced similar problems. “On January 1, 2009, much of the hedge fund playing field looked like a disaster area,” recalls Alex Ehrlich, global head of prime brokerage at Morgan Stanley in New York. “Performance had been poor, some funds had suspended redemptions, and a lot of hedge funds were way below their high-water marks” — meaning that, until they earned back their losses, firms couldn’t charge performance fees.
By the beginning of this year, the picture looked quite different. In 2009 hedge funds were up, on average, about 20 percent, according to data provider Hedge Fund Research in Chicago, compared with a 19 percent loss in 2008.
“Over a two-year view hedge fund performance was really very decent on a relative basis,” Ehrlich says. “Investors have largely gotten comfortable with lessons learned from how gates and suspensions were employed.”
The change in attitude can be measured by the metric that matters most to hedge fund managers: money. After a nearly two-year hiatus, investors are once again allocating new capital to hedge funds, and the firms on Institutional Investor’s Hedge Fund 100 are the major beneficiaries. The 101 managers in our ninth annual ranking of the world’s largest single-manager hedge fund firms — there is a four-way tie for No. 98 — managed a combined $1.08 trillion in assets at the start of this year. That’s up nearly 5 percent from the $1.03 trillion in assets that the firms on the 2009 Hedge Fund 100 had one year earlier but still a far cry from the record $1.35 trillion the world’s biggest hedge funds managed at the end of 2007.
Behind the improving facade, however, hedge funds are still working through plenty of issues — keen to figure out how to upgrade and refine their operations to attract pension funds and other institutional investors. Highbridge, in fact, was one of the first hedge funds to institutionalize its business, a process that got a boost in 2005 when J.P. Morgan purchased a majority stake in the firm. By putting up gates during the height of the crisis, Highbridge was able to avoid selling its convertible-bond positions, which rebounded in 2009 as spectacularly as they had fallen the previous year, helping propel the firm’s flagship multistrategy fund to a 39.2 percent return — its best year ever. According to Dubin, the firm in the end did right by its investors, returning 90 percent of the gated assets in its multistrategy fund within nine months (they also earned returns of 22 percent on those assets). “We were able to change a negative into a positive,” says the Highbridge CEO. (Swieca, his co-founder, left Highbridge last year and is starting his own firm, Talpion.)
The ability of Dubin and his team to quickly right the ship has helped J.P. Morgan, which has $45.1 billion in total hedge fund assets, to overtake Bridgewater Associates and climb to the top of the Hedge Fund 100. Dubin believes that hedge fund managers’ actions during the crisis and its aftermath will mark their firms’ reputations for life.
Reputation is even more of an issue today because the majority of money going into hedge funds is from endowments, foundations, insurance companies, pension funds and sovereign wealth funds. “Almost all the inflows right now are from institutions, either allocating directly or via those larger funds of hedge funds that have always catered to institutional clients,” says Jim Vos, CEO and head of research at New York–based consulting firm Aksia, which advises institutional investors on hedge fund investing. Such investors can be picky, of course. They have power, in the form of deep pockets and long time horizons, which they are not afraid to wield. Brand matters to them.
Few if any firms have built a better institutional brand than Westport, Connecticut–based Bridgewater Associates, No. 2, with $34.6 billion in hedge fund assets. Bridgewater offers separate alpha and beta strategy funds. Its founder, president and CIO, Ray Dalio, has been educating the institutional investment community on the relative merits of true alpha and hedge fund–like strategies since the 1980s. Although Bridgewater’s flagship Pure Alpha II strategy was up just 2 percent in 2009, it has delivered a 15 percent compounded annual return during its 19-year lifetime.
Samuel Hocking, global head of sales for prime brokerage with BNP Paribas in New York, says large hedge fund firms are keen to attract capital that can be locked up for long durations. The crisis has also made them realize the importance of marketing. “Hedge fund managers need to make sure they understand all the channels of distribution” to have a broad investor base, he explains. “Because you never know where redemptions are going to come from.”
One hedge fund firm marketing itself through many channels is Paulson & Co. Its founder and president, John Paulson, says he is focusing his fundraising on investors with long investment horizons. Paulson became a household name in 2007, famously earning $3.7 billion betting against the subprime mortgage market. (One of the collateralized debt obligations that according to a Securities and Exchange Commission complaint Goldman, Sachs & Co. co-structured with input from Paulson is now the subject of a civil fraud suit against the investment bank by the Commission concerning Goldman’s alleged failure to adequately disclose Paulson’s role in the selection of collateral for the CDO.) The New York–based firm has leapt from relative obscurity, No. 74 on II’s Hedge Fund 100 in 2006, to remain No. 3 today.
Now some investors are asking if Paulson & Co., with $32.1 billion under management, has grown too big, too quickly. It is a charge Paulson himself passionately denies. He points out that he is the largest single investor in the firm — he put 100 percent of his 2009 gains back into Paulson funds — and says he is excited by the investment prospects through 2012. “At some point in the future, we are likely to close the funds,” he says. “As of now we are able to deploy capital in line with our risk-return metrics, so our funds are open.”
The largest non-U.S. hedge fund firm is London-based Brevan Howard Asset Management, which ties with Soros Fund Management at No. 4, with $27 billion in assets under management. Formed by a team of former Credit Suisse First Boston macro fixed-income proprietary traders led by Alan Howard, the firm has delivered annualized returns since its 2003 inception of 14 percent in its flagship Brevan Howard Master Fund, including an impressive 20.43 percent return in 2008. Howard and Moore Capital Management (No. 21, with $14 billion) founder Louis Bacon were among the global macro hedge fund managers to insist, earlier this year, that they were not trading credit default swaps on the sovereign bonds of struggling euro-zone countries such as Greece.
A macro manager who has made no secret of his negative views on derivatives is George Soros, who launched his New York–based Quantum fund in 1970. While many of his early rivals have either scaled back or faded away, Soros has built one of the most enduringly successful hedge fund firms. Still, Soros historically has had problems passing the torch. In recent years, after some lackluster performance, the 79-year-old philanthropist and liberal political activist has become more involved again in his firm’s investment decision-making. But the appointment of Keith Anderson, co-founder of asset management giant BlackRock, as CIO of Soros Fund Management in 2008 appears to be working. The Quantum fund returned 29 percent last year.
No hedge fund firm has had a smoother management transition than D.E. Shaw & Co. (No. 6, with $23.6 billion in hedge fund assets), which was established in 1988 by former computer science professor David Shaw. Today, D.E. Shaw is managed by a six-person executive committee, and its founder has joined the war on cancer through D.E. Shaw Research, an entirely separate, 100-person laboratory that is using supercomputers to create 3-D molecular simulations to study protein folding.
Like many of the largest hedge fund firms, D.E. Shaw has gone out of its way to court institutional clients and diversify its business. In 2000 it launched a traditional asset management business. Trey Beck, a member of D.E. Shaw’s operating committee and of the four-person executive committee for the firm’s traditional business, says the firm has always had a healthy sense of paranoia. “We don’t wonder whether the financial world might melt down one day; we assume it will and plan accordingly,” says Beck.
As a result, D.E. Shaw was better positioned than many firms, especially those with a lot of relative-value strategies, during the credit crisis. Still, Shaw’s trip through the economic meltdown wasn’t without its bumps. The firm’s two main funds put up gates, which were later lowered. Though D.E. Shaw has lost 22 percent of its hedge fund assets this year, investors say that, once the residual redemption issues are behind it, inflows should start to improve again.
The credit markets rebounded sharply in 2009. But the fortunes of credit funds have been mixed. Marc Lasry, chairman and CEO of Avenue Capital Group (No. 12, with $20 billion in assets), says a key differentiator among credit managers is their fund structures; those whose assets and liabilities were properly aligned, and which were therefore not forced to make redemptions or raise gates in 2008, have fared the best. “Most credit funds believed that what they owned was ‘money good’ but trading substantially below the ultimate values,” Lasry explains. “The question was, did you have the time or the ability to wait.” Before the crisis, Avenue had raised funds with long lockups. “We thought that when things got bad they would get really bad, and we wanted to have the capital to take advantage of it,” says Lasry, whose flagship Avenue Investments fund was up 66 percent in 2009.
More than a dozen firms drop off the Hedge Fund 100 this year, including Galleon Group (No. 85 in 2009), which was torpedoed by allegations of insider trading by its billionaire founder Raj Rajaratnam. Atticus Capital (No. 50 in 2009) shut down its main fund after suffering huge losses in 2008, as did Horseman Capital Management (No. 66 in 2009).
Not all firms have shared equally in the growth in demand from institutional investors. Despite annualized investment returns close to 16 percent, Millennium Management, which falls more than 30 places, to No. 60, after 2009 redemptions, has had a hard time getting many traditional institutional investors to invest. A major sticking point is that the New York–based firm charges expenses instead of a management fee, and investors fear fees they cannot predict.
Millennium founder, chairman and CEO Israel Englander, however, is sticking to his guns. To him, charging expenses is the way to operate a hedge fund like a true partnership, in which everyone shares in the cost (including Englander, who is his firm’s biggest investor). Millennium’s fee structure enables the firm to compete for talent with the likes of the proprietary trading desks of Goldman Sachs and Morgan Stanley, which Englander views as his true competitors. He rejects the notion of an institutionalized hedge fund industry. “Hedge funds will never be ‘institutionalized’ like a Vanguard or a Fidelity,” he says.
But even Millennium is making an effort to attract institutional assets. The firm now has a compliance staff of 30 people, led by vice chairman and chief legal officer Simon Lorne. And Englander recently hired from Fortress Investment Group (No. 22, with $13.8 billion in assets) John Novogratz, the brother of Fortress president Michael Novogratz, to spearhead its marketing and investor relations effort. Novogratz knows his role will be a challenging one. “We may look a lot more institutional,” he agrees. But, he adds, wryly, “it’s important that we don’t lose our special sauce.”
