Soros Imitators Reap Riches in Financial Crisis on Macro Funds

Date: Thursday, February 5, 2009
Author: Richard Teitelbaum, Bloomberg

Hedge fund managers on average lost 18.7 percent of their clients’ money in 2008, for the worst performance since at least 1990, according to Hedge Fund Research Inc. Combine the losses with investor redemptions, and total hedge fund assets have been cut almost in half. TrimTabs Investment Research and Barclay Hedge Ltd. estimated funds held $1.1 trillion at the end of the year, down from $1.9 trillion a year earlier.

One rare bright spot: the resilience of global macro fund managers, who wager on currencies, equities, interest rates and commodities based on their fundamental analysis of world economic trends.

Their funds gained 5 percent on average amid the carnage, according to Chicago-based Hedge Fund Research, prompting investors and managers to predict a renaissance for the once ubiquitous strategy. Preliminary estimates show macro funds up another 1.4 percent in January.

“Twenty years ago, the words hedge fund meant global macro,” says Colm O’Shea, founder of Comac Capital LLP in London, a macro firm with $1.3 billion under management and returns of 30.7 percent last year. “I believe they will again in the future.”

Alan Lenahan, managing principal of Fund Evaluation Group LLC, a Cincinnati-based investment advisory firm, says macro funds will garner a bigger share of the money that he expects will flow back into the industry. “You’re going to see investors flock to global macro,” he says.

The multiyear performance of hedge funds overall, even including 2008, justifies a place in most portfolios, he says. Pension funds, endowments and wealthy individuals will return, despite having withdrawn money since last summer, he says, and they will favor what’s been working best.

Fund Withdrawals

“There’s a lot of money that’s been pulled out of the hedge fund industry,” says Cary Stier, Deloitte LLP’s U.S. head of asset management services. “There’s a lot of money that’s going to have to go back in.”

Investors withdrew an estimated $236 billion from hedge funds from September through December, according to TrimTabs in Sausalito, California. With investment losses, total hedge fund assets fell to their lowest level since 2004, the firm found.

Some managers prevented a bigger exodus only by imposing restrictions on redemptions, known as gates. Citadel Investment Group LLC’s Ken Griffin, for example, suspended redemptions in the firm’s Kensington Global Strategies and Wellington funds, according to a Dec. 12 letter he sent to investors.

Star managers forced by losses to shut funds include Dwight Anderson of Ospraie Management LLC and Jeffrey Gendell of Tontine Associates LLC.

Style Change

The path the hedge fund industry took as it grew, shifting away from global macro, has made its recent declines worse. In the early 1990s, macro managers dominated. George Soros of the Quantum Fund, Louis Bacon of Moore Capital Management LP and Bruce Kovner of Caxton Associates LLC made headlines -- and sometimes billions -- with their wagers.

Credit Suisse Group AG’s AES subsidiary calculates that 65 percent of all hedge fund assets were run by global macro managers at the start of 1994. By contrast, equity-oriented “long-short” funds, which make leveraged bets on rising and falling stocks, were 15 percent of assets. So-called event-driven funds, wagering on stocks based on corporate developments such as earnings surprises or restructurings, were 7.4 percent.

Things changed as commissions and spreads on stock transactions shrank in the late 1990s, making equity trading cheaper -- and more profitable. When the technology stock bubble collapsed, pension fund money began to flood into hedge funds, and much of it was directed by consultants into equity strategies. These were easy to market compared with a macro fund, for which a manager might have to explain the outlook for the yield curve, say, or the Japanese yen.

Equity Strategies

By the start of 2008, long-short funds accounted for 29 percent and event-driven funds were 24 percent of the total assets. Combined, that’s almost five times the 11 percent managed with a macro strategy.

As it turns out, the equity strategies were not particularly well hedged. That didn’t matter much until the stock market plunged. While the long-short funds beat the Standard & Poor’s 500 Index, they still lost 26 percent last year, and event-driven funds dropped 21.5 percent.

“On average, funds did not do what they represented they could do, which is to make money in up-and-down markets,” says Sol Waksman, founder and president of Barclay Hedge, a Fairfield, Iowa-based firm that tracks and invests in hedge funds.

Macro’s Advantages

There are hazards, to be sure, in chasing the performance of a particular investing style. Macro funds sidestepped the losses in the bear market of 2000-02. Then they trailed the S&P 500 for the next five years by an average of 2.7 percentage points a year.

Still, macro investing has some vital advantages as the financial crisis runs its course. Unlike more-popular styles, macro investing requires little or no borrowed money, or leverage, to produce returns. That’s a key to success now that prime brokerages and investment banks have slashed lending.

Also, in the highly liquid foreign exchange and futures markets where macro funds play, there are few constraints on asset size. That means macro funds don’t suffer from the crowded trades -- with too many funds chasing the same stocks or bonds -- that caused big losses last year.

Strategies that depend on borrowed money will be hobbled, says Carrie McCabe, founder of Lasair Capital LLC, which invests in a variety of hedge funds. “Anything that requires leverage is dead,” McCabe says, citing convertible arbitrage, fixed-income arbitrage and certain kinds of relative-value funds.

In addition to macro funds, McCabe thinks long-short equity and event-driven funds will prosper because of the bargains in the beaten-up stock market.

Less Competition

The shakeout that has reduced the total number of hedge funds may help investors too. “There’s more opportunity for hedge fund capital because there’s less competition,” says Irvin Goldman, founder of IJG Advisors LLC, a New York-based consulting firm.

Hedge fund managers will need every opportunity. Even as the industry starts to lure investors back, its profits may be pinched. Many funds have high-water marks that prevent them from taking a performance fee until investors make back the money they lost. Some managers have been negotiating with clients for a small performance fee now in exchange for a reduction of future fees. That means the famous “2 and 20” fee structure -- the 2 percent annual management charge and 20 percent of profits that managers have long claimed -- may no longer be the norm.

To contact the reporter on this story: Richard Teitelbaum in New York at rteitelbaum1@bloomberg.net.