A Diverging Market
At the moment, the hedge fund market appears to be fragmenting into two distinct groups. On one hand, you have the big hedge funds that have billions of dollars under management, a large team of portfolio managers and analysts, sophisticated risk management, and solid infrastructure. On the other, you have smaller, nimbler hedge funds that have much less in the way of an administrative burden, and recently studies have suggested that these funds can tend to be more profitable than older and bigger funds.
This makes sense when viewed in the context of how the hedge fund industry evolved in the 1980s. When Julian Robertson’s Tiger Fund wowed the market with its double-digit returns – substantially better than even the top-performing mutual funds – it was a small concern, and their small size was one of the main things that gave them an edge over their slower-moving counterparts. Today, in an age when billions of dollars are being poured into hedge funds from institutional investors, vastly increasing the administrative burden, the advantages of staying small and agile are becoming more pronounced by the day.
You might think that this would lead institutional investors away from the larger, more established funds, but in practice the opposite is happening. With the bigger funds offering much more in the way of accountability and risk management, they seem to be a much safer bet. At the start of the year, the 100 biggest hedge funds in the world had $1.51 trillion under management, a 14% increase on the 2013 figure of $1.33 trillion, and over the past two years, the assets of the top 100 hedge fund firms were up nearly 25%.
Across the entire industry, the scale of assets under management grew by 9.7% in 2013 to $2.85 trillion, after rising 5.9% the previous year, with the top 100 firms accounting for more than 50% of the total assets of the industry, a figure which is on the increase. In fact, the rate of asset growth for the biggest 100 hedge funds is far greater than the industry-wide figure, which sugggests that performance is not the only factor driving asset growth.
With larger pension plans moving into alternative investments, they need to use the bigger funds that can handle the allocation sizes – typically $50m or $100m – as risk management best practice demands that any allocation should only account for a small percentage of the total assets of a fund. If they were to split these allocations into more manageable amounts – such as $5m or $10m – they would end up with too many funds, and this would make it too resource-intensive to monitor their performances.
Small is Beautiful?
But while more and more money is going towards the biggest funds, not all of these funds welcome this increased interest, with several major firms closing some of their funds to new investors in the last year. These include Citadel, D.E. Shaw & Co, Viking Global Investors, and Convexity Capital Management, while many others returned capital to investors in 2013 with Appaloosa Management, Highfields Capital Management, Third Point returning $2 billion each and the Baupost Group returning $4 billion. This is a sign that funds are seeing greater advantages to staying within a certain size rather than expanding as fast as the asset inflows allow.
This is because certain strategies can tend to be less effective when the amount of capital goes up beyond a certain threshold – for example equity long/short. While some strategies require more resources than others – for example distressed investment and statistical arbitrage – there is usually a sweet spot beyond which larger amounts of capital can prevent a fund from having the agility necessary to capitalise on certain opportunities. In strongly rising markets, big trade sizes can directly influence price, reducing the profit percentage even if the net return is larger. At the same time, smaller trades have less influence on the overall results for the fund, and these are two of the main reasons why larger funds tend to post less impressive results than the big ones.
The biggest capital returner in 2013, Seth Klarman’s Baupost, sees advantages and disadvantages to size. In a note to investors, Klarman wrote “We are able to triple or quadruple team the most complex and fast moving opportunities, have sufficient staff to analyse an industry or geographic opportunity that a smaller competitor couldn’t pursue, negotiate with limited or no competition for sizeable transactions in public and private markets from urgent sellers, and staff an operations team to handle even the most complex investments without missing a beat”
However, he concedes that size can limit a firm’s ability to be nimble “while rendering smaller positions less impactful on the overall result. Greater size is a disadvantage in strongly rising markets”. After returning capital for only the second time in its 32-year history, Klarman explained that unless investment opportunities dramatically improved, their intention was to “better match our assets under management with the opportunity set we see for new investments”.
Another high-profile capital returner is David Tepper of Appaloosa, which has given back $5 billion since 2010, and $10 billion over the 21-year history of the fund in an effort to keep the fund at an optimal size.
The Biggest Get Bigger, Despite Poor Returns
Not everyone is downsizing, though. For the fourth year running, Ray Dalio’s Bridgewater Associates is the biggest hedge fund in the world, with $87.1 billion under management at the beginning of 2014, and assets rising 4.6% last year. This is in spite of the relatively poor performance of his flagship funds, with Pure Alpha up just 3.5%, Pure Alpha Major Markets up 5.25%, and All Weather losing 4.62%. However, these funds have performed better over the past ten years, with annualised returns of 8.6%, 11.8% and 7.7% respectively.
In second place, also for the fourth year in a row, is JP Morgan Asset Management, owners of Highbridge Capital Management, with $59 billion. Multistrategy fund Highbridge rose 6.5% after gaining 9.79% in 2012 and dropping 5.11% in 2011. Third place goes to Brevan Howard Asset Management with $40 billion under management, which has been in the top five for the past six years, with its $27.8 billion Brevan Howard Master Fund posting a 2.6% gain, narrowly avoiding its first loss-making year.
Fourth place goes to Daniel Och’s Och-Ziff Capital Management Group with $36.1 billion in assets under management, up nearly 20%. This is the only firm in the top ten to have been growing assets rapidly, and the main reason for this is that Och-Ziff is the only alternatives firm to list on the NYSE, and its shares are valued partly on income growth and dividends, which depend on growing assets. This means that the performance of their funds tends to be lower than many others, although it also tends to be steadier, with 37% less volatility than the S&P 500 in 2013. Last year, its flagship OZ Master fund made 13.9%, which is better than most of the top five biggest funds, but a long way behind the overall gains of the stock market throughout the year.
Elsewhere in the top ten, there were three new entries, including two founded by Tiger Cubs (former proteges of legendary investor Julian Robertson) – Lone Pine Capital and Viking Global – and also the multi-strategy AQR Capital Management.
In this series, we shall be counting down the top 50 biggest hedge funds in the world, ranked in terms of assets under management, based on the list published by Institutional Investor’s Alpha magazine.
Other articles in this series
Top 50 Hedge Funds in the World Part 2: 50-42
Top 50 Hedge Funds in the World Part 3: 40-31
Top 50 Hedge Funds in the World Part 4: 30-21
Top 50 Hedge Funds in the World Part 5: 20-11
Top 50 Hedge Funds in the World Part 6: The Top Ten