Hedge Funds as Asset Management Complexes - The Day Has Come
Yesterday’s story in the FT about DE Shaw making a push into traditional asset management was the straw that broke this camel’s back. The theme of convergence is one I’ve written about on several occasions during my short stint as a blogger. Closely related to this theme is that of the structure of the hedge fund industry in general, which, in my opinion, will increasingly resemble that of a barbell (mega-institutional asset managers on one end and emergent single strategy managers on the other). But come on, a few days ago it was talk of the $20+ billion Fortress Investment Management’s lingering plans to go public (at some say a valuation of, what, $6 billion?!?) and now this? It was the language in the FT story that really made me sit up and take notice:
Trey Beck, who is in charge of developing the institutional business for DE Shaw, said the group, which manages $23bn in hedge fund strategies, had only about $300m in traditional asset management but planned to increase this substantially and had just won three new mandates.
“We are in the [traditional] business to manage tens of billions of dollars, and I can envisage a time when DE Shaw will have traditional asset management funds in excess of the hedge fund business,” he said.
“In ten years’ time it will be less important whether you are a hedge fund or a traditional manager, but whether you can generate alpha [above-benchmark returns]”, he said.
Trey is certainly sounding very institutional, very un-hedge fund like. He sounds like Barclays Global Investors’ describing their Alpha Tilts (index plus alpha) strategy. Let me reiterate; very un-hedge fund like. This is not to say that what DE Shaw is doing is bad or wrong, or that Jim Simons earlier decision to open a long-only strategy at Renaissance is either, only that the hedge fund industry as we know it is changing and will continue to do so.
Take Fortress for a moment. They have special situations, macro, distressed, second-lien financing, and private equity. This, my friends, is an institutional asset manager. All they need is a long-only equity book and they’ll have it all. DE Shaw itself has statistical arbitrage, both quantitative and bottoms-up long/short strategies, as well as Laminar, which does distressed debt investing and which occasionally takes an activist stance in reorganizations. I am sure they have other strategies under that massive umbrella as well. With the inclusion of a long-only (or primarily long with a limited ability to short) strategy of scale, DE Shaw itself will become a diversified asset management complex. But why?
Let me offer a few possible reasons:
1. Legacy: Managers like Jim Simons and David Shaw (not to mention Wes Edens and his partners) want to build something that will last beyond their personal involvement. By creating a diversified array of strategies and delegating a sufficient amount of investment and risk management control to their portfolio managers, one can envision a DE Shaw, a Renaissance or a Fortress being successful long after their rock star founders have moved on.
2. Scale: Long/short strategies, by their nature, do not have massive capacity. The short side is forever a constraint that weighs on asset growth beyond a certain threshold, depending upon the capitalization and float of the stocks being shorted. Long-only (or principally long-only) strategies have the benefit of growth far in excess of that of conventional hedge funds; one only need look at the monster funds run by Capital Research or Fidelity to see how performance can be maintained in the face of scale on the long side. Jim Simons said his long-only strategy had capacity of $100 billion. Even without the performance fee that kind of cash flow looks pretty good.
3. Addressing a market need: Top performing managers running high quality, institutional-caliber infrastructures are not easily found. DE Shaw is one of those managers as is Renaissance. There is, quite simply, excess demand for their services. Given the constraints mentioned above concerning scalability of long/short strategies, it stands to reason that they would look beyond their principal areas of focus to address this burgeoning demand. Further, given that they are both quantitatively-oriented shops, it is not a leap for them to adapt their algorithms to a long-only model. This is smart from a business sense and neatly helps to address points (1) and (2) above.
This emergence of the institutional asset manager from traditional hedge fund roots is a new thing and, I believe, a positive thing both for these firms and for their clients. I am very confident in saying that this won’t be the last we hear of top hedge funds making the leap into the long-only domain, with the consequence being the development of a hedge fund uber class that dominates the alternative investment landscape.
