While the S&P is struggling to eek out some modest gains for the year in the last month of the year, for hedge funds 2018 has not only been a scratch, but also one the worst years since the financial crisis, as the following chart – which reveals that most hedge funds haven’t generated any alpha (or beta) in the past four years – shows.
Earlier this week we reported that notable name, Balyasny Asset Management, was hit especially hard when between losses in 2018 and client redemptions, the fund lost over $4 billion in AUM, leading to the termination of 20% of its work force. However, it was not until November, that some of the most marquee names were hammered for the first time in years.
According to Bloomberg, the holy trinity of multi-strategy hedge fund managers who run “silo” based asset management firms, billionaires Ken Griffin, Izzy Englander and Steve Cohen, posted monthly losses in November that ranked among their worst ever as stock hedge funds dumped holdings at a rate not seen since the financial crisis, while other assets such as credit and oil suffered dramatic losses.
Griffin’s Citadel lost about 3% last month, its poorest showing since the first quarter of 2016 when Citadel’s Surveyor Capital suffered jarring losses on its commodities book. Englander’s Millennium Management, which has had a remarkable – some say almost Bernie Madoffesque – track record of virtually never posting a down month, slid 2.8%, its third-worst month on record. Meanwhile, Cohen’s Point72 Asset Management – which this year was reopened for outside investors – lost 5%, wiping out its 2018 gains.
What is notable is that the three multi-strat funds stumbled after posting surprisingly strong numbers in October when stocks suffered even greater losses, and when the multi-manager firms rode out a nearly 7% plunge in the S&P 500 Index with only minimal losses. However, the contagion from equities, which sent both credit and commodities tumbling, finally took its tool. And, according to Bloomberg, the damage suffered by these hedge funds underscores the risk faced by firms that farm out money to dozens of internal managers who all run their stock portfolios in similar ways: When other hedge funds cut and run, the multi-manager giants can get caught up in the havoc, i.e., when one investor tries to flee a burning hedge fund hotel, they all do, and the result ends up being a disaster.
The disappointing numbers are especially remarkable as the three firms market themselves as “market-neutral” and steady money makers as their managers tend to run portfolios with a roughly equal weighting of longs and shorts, or small net exposure in either a bullish or bearish direction, while “neutralizing” style, factor and sector biases.
Alas, as November showed, these mandates tend to crowd the firms – whose PMs have usually “been around the block” and have worked at all the same companies – into the same trades.
Furthermore, because individual PMs are typically forced to sell positions after relatively small losses by their back office risk controller, the firms are forced to employ massive leverage to capture upside. As a result, while Citadel, Point72 and Millennium together hold less than $100 billion in net assets, that number rises to almost half a trillion dollars when leverage is accounted for is included in the firm’s “regulatory capital”.
So when did the great multi-strategy wipeout begin? According to a recent report by Morgan Stanley, the unwind began in the latter half of October when traditional long-short funds, facing losses on the month and year as markets slumped, began selling long holdings and buying to close out shorts, resulting in several days of violent short squeezes (which we documented extensively). Over the next month, Morgan Stanley noted that funds sold out of their U.S. long stock positions at a magnitude not seen since the financial crisis. Their trades eventually hit the multi-managers, who saw their longs drop while their shorts rose in value (i.e. one of those teeth crushing events that Nomura’s Charlie McElligott discussed in the past two weeks).
And thus – as Bloomberg notes – began the cycle of liquidation at the multi-manager firms, as individual PMs or teams hit their risk limits, forcing them out of various positions and beginning a cycle of losses and further sales.
Separately, Morgan Stanley said that while gross and net leverage for equity hedge funds had reached lows for the year last month – around 179 percent gross and 43 percent net – something which Goldman Sachs also observed in its Q3 13F summary report…
… there was still room for them to fall more based on previous market dislocations. That could mean more selling and additional losses if markets fail to stabilize in the coming days, especially because hedge fund managers traditionally deleverage further at the end of the year.
That said, don’t discount the multi-strats yet: while beatdowns like November were rare, the three firms above have rebounded from de-leveraging events relatively quickly in the past. Readers will recall how Citadel, which slumped 8% in early 2016 ended the year up 5%. Millennium dropped 2.7% that February yet finished with a 3.3% gain.
Even after a dismal November, in 2018 Citadel is still up 8.5%, outperforming over 95% of its peers, while Millennium has gained 4.2%. Perhaps indicating that some of his prior “expert network” magic has now vanished, Steve Cohen is flat for the year. Maybe that’s something for the next season of “Billions” to address.