When BlueCrest, a macro fund that ran $35bn at its peak,
closed this month and undertook to return all of its outside money to
investors, it did so to allow the bosses to devote themselves to managing their
own substantial wealth, including that of founder Michael Platt. Few would
dispute that this was a better use of their time based on recent performance.
While the main fund had essentially been flat, net of fees, for the past three
years, an internal one that BlueCrest runs solely for staff was reportedly up
by about 60 per cent over the same period.
Even setting aside the full 1.5 per cent management charge
and 20 per cent profit share, which the $2bn mini-fund did not have to pay,
that is still a startling gap. Of course, it is not uncommon for the managers
to do better than the clients. According to research by Simon Lack, a former
hedge fund investor, insiders have devoured 95 per cent of all the returns
these investment vehicles have made since 1998. But that is normally down to
the difference between receiving high fees and paying them. It is less
customary for managers to have their own mini-fund rather than co-investing
alongside the rank-and-file punters. Indeed, this is one of the factors that
may have precipitated BlueCrest’s ultimate closure. Irked by their own paltry
winnings and the perceived conflict of interest, some investors had been
withdrawing their cash.
To some this will be yet more evidence that hedge funds are
simply out to milk their clients. How else to explain the divergence in
returns? But there are plenty of reasons the mini-fund could have done better —
including a more voracious risk appetite and the ability to take opportunistic
positions. Indeed, what BlueCrest’s story may really illustrate is less the
roguery of hedge funders than a more fundamental reason why institutional money
and these firms should not mix.
Retirement plans have expanded dramatically their exposure
to hedge funds. This is one reason the sector has nearly doubled in size since
the financial crisis. Of the $3tn it has under management the majority comes
from institutional hands. Yet it is not clear the arrangement works well for
either party. The inflow of cash into a subset of consultant rubber-stamped
firms has created a group of supersized funds. Scale may bring bucket loads of
fees, but it also causes problems for the recipients. It becomes
harder to devise distinctive strategies. Funds find it more difficult to move
in and out of positions without moving prices against themselves.
Add to that the risk controls that pension funds place on
managers, such as the requirements to stick to settled strategies and use more
modest leverage, and these kill the entrepreneurial spark that gave many firms
their edge.
Pension fund investors bear the brunt of this diminished
performance. Yet at the same time, and for all their buying power, they
continue to pay elevated fees.
According to figures Calpers disclosed when it pulled out of
hedge funds last year, even one of the biggest US retirement plans was paying a
figure equivalent to 2 per cent for management and 18.5 per cent for
performance. That is slightly better than the fabled “2 and 20” — but not much.
So what explains this unhappy marriage? One factor may be
pension fund accounting. It is well known that American public sector schemes
herd into hedge funds because of the costly past promises they have made to
beneficiaries. But the lure is not just the extra returns they may hope to
receive; it is also a quirk of accounting rules. This allows them to discount
their liabilities not based on corporate bond yields but the expected return on
their assets. So the riskier the asset mix, the higher the assumed return, and
the lower the bill consequently seems to be.
It is a regulatory arbitrage that profits some big hedge
funds, pushing money at them on which they can charge high fees. The snag is
all the constraints that come along with the cash. With its mini-fund —
established for “staff retention” purposes — BlueCrest seems to have been
trying to have the best of both worlds. There are good hedge funds and
investors have profited from backing them. But pension trustees need to ask
themselves where all this is leading. To this one might add that pensions are
ultimately paid in hard cash — and not accounting games.
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