“We wanna be free! We wanna be free to do what we wanna do!”
Heavenly Blues (played by Peter Fonda), The Wild Angels Film, 1966 (via Screamadelica’s Loaded)
“Oh, you’re no fun anymore!”
Monty Python sketch, TV series 1, Episode 7, 1969
Should we have seen it coming? Yesterday, only a few weeks after offloading its stake in Systematica, venerable hedge fund BlueCrest announced that it would be eschewing external investors to focus on managing internal assets (i.e. those of the founders and colleagues).
Such events aren’t unique but are still rare enough to grab our attention, particularly when the organisation has such a blue chip reputation. Why is this move so significant?
It isn’t because of the oft-cited headline reason, namely the alleged unprofitability of the hedge fund model in modern times, but clearly based upon what founder Mike Platt is reported as saying you can see that this has a part to play.
Certainly, Platt’s comments about fees highlight some key reputational issues circling the industry today. We only need to look at the volume of external research on hedge funds to see how headline fee numbers distort reality – see the latest EY report for example. Despite analysis to the contrary, actual hedge fund fees do not defy gravity as is often portrayed. Yes, the more successful (ergo, larger) funds are often well-positioned to charge a premium for their scarce skill-resource but in a world where ‘asset management’ is everything and ‘asset-gathering’ is viewed very much in the pejorative sense, traditional economies of scale do not always equate. Naturally, big ticket investors have the privilege of demanding discounted pricing.
But you have to place Platt’s comments about fees in the context of what else he has been reported as saying. Buried deeper within much of the coverage is the admission that the level of risks demanded by clients aren’t aligned with the level of risk that the business wants to take with its own assets. Clearly, it seems for someone who has been so successful for such a long time, no viable amount of fees is enough to make managing client assets on that basis worth their while any longer – not from a cost perspective, and equally I suspect, not from a fulfilment basis either. If you take the conviction out of a conviction manager what are you left with? If you constrain the previously unconstrained, what scope does that leave you with?
This throws up a far more important industry issue. In the old days, the purpose of managers such as BlueCrest was obvious – providing diversification to traditional assets. For anyone not familiar with this concept, the idea is that by marrying up non-correlated but risky assets at the right levels over time, that you achieve a stable, less risky path to achieve your investment objective. Post-crisis, correlations between risk assets have risen and haven’t really normalised, and many investors have adopted a worryingly consensual “risk-on/risk-off” approach as a response to the quantitatively-eased, negative real interest rate environment they find themselves in. According to many within the industry, and this is echoed a little in Platt’s words, investors are simply not taking enough risk to achieve their goals, and this is creating a dilemma for asset managers. How can you be a partner to investors on the journey if you don’t believe in the route they are demanding you take?
I wonder if this is what Platt and his now retired co-founder William Reeves had in mind when they set up in 2000. Back then, hedge funds were cool, in the way that fintech companies are now. They also provided a similar “disruptive” influence on the traditional asset management industry, just as many start-up businesses are challenging traditional financial institutions today. For the CEOs of mainstream fund managers, in the wake of the collapse of the tech bubble, this was a tough period. They had clients criticising them for delivering expensive, index-like returns along with balance sheets that said they were spending a lot of money on delivering index-like returns. So they looked enviously at the hedge fund model: small, dedicated investment teams; streamlined decision-making; unconstrained, conviction-based portfolios; outsourced back office functions; skin in the game; and, attractive fee structures, and very much liked what they saw. Many asset management businesses have transformed themselves since then.
In those days, hedge funds were still largely the preserve of ultra HNW investors, but the transition to an institutional client base happened rapidly, compounded by the decimation wrought by the banking crisis in 2007/8. And from then on, greater controls have been placed on the industry. Which rather begs the question; if hedge funds are finding the constraints placed upon them too much to take, who left could bear them?