We live in dynamic times with significant changes happening in the US and abroad at warp speed. Those matters are opined upon on every news channel, every minute of the day. The macro environment does have an affect on the investment business.
Within the hedge fund world, Multi Strategy Hedge Funds known as Multi-Strats, or pod shops, are garnering center stage. From eye-popping Manager and PM compensation, to returns that are what dreams are made of, everyone is trying to get a piece of the Multi-Strat craze. By definition, multi-strategy funds engage in a variety of investment strategies. The diversification benefits help to smooth returns, reduce volatility and decrease asset-class and single-strategy risks. Multi-strategy hedge funds are hedge funds that use a variety of investment strategies, such as long/short equity, event-driven, and relative value. This allows them to generate returns in a variety of market conditions and reduce risk. Top multi-strategy hedge funds include Citadel Investment Group, Millennium Capital Partners, Balyasny Asset Management and AQR Capital Management The top 50 multi-strategy hedge funds globally manage over $1.9 trillion in assets.
We have been a significant and early investor in Multi-Strats since our inception 20 years ago. Furthermore, I was a portfolio manager for Millennium Partners on two separate occasions during the 1990s so I’ve witnessed the growth of these businesses first hand. Historically, in my view, there has been no better example of the value-add that hedge funds can offer. The risk-adjusted returns and the smoothness of these returns has been nothing short of miraculous. However, it is in my DNA to be on heightened alert as to what can go wrong once something has captivated the world’s attention.
The early pioneers of the multi-strat model deserve to reap all the rewards and accolades for inventing a business that appears to be too good to be true. Looking back, it has been one of those rare win-win strategies whereby the General Partner, the PMs, the staff, and, the investors are all handsomely rewarded concurrently.
Increasingly, I have noticed an increased short-term correlation of weekly and monthly returns by and amongst the Multi-Strats. We often receive weekly performance figures from the Multi-Strats that we have relationships with. The logical implication of this is the crowding effect of similar positions across these Firms. This is not surprising given the fact that PMs routinely move from one platform allocator to another bringing with them a similar knowledge and approach.
Could there be a “Multi-Strat” quake? It’s certainly possible. The larger multi-strats control upwards of $50 Billion of actual cash each. The business model calls for 5-10 leverage across a highly diversified group of strategies or pods. Notional allocations to a pod can range from $250 Million to multiple billions and utlize leverage themselves, albeit, generally in a market neutral manner. Therefore, the larger Multi-Strats can each control upwards of a trillion dollars of notional market positions overall. Market neutral does not necessarily connote risk neutral. Rather, longs can go down and shorts can go up concurrently creating losses on both sides. The likelihood of this happening is higher if the Multi-Strats are forced into a liquidation loop with one Firm’s deleveraging causing a domino effect upon the others. Incidentally, this is not a prediction rather, simply a possibility especially given the amounts of assets gathered by the Multi-Strats over the past few years.
So, are Multi-Strats too big to fail? I’m not certain but frankly, i think so. The mass liquidation of a large Multi-Strat would likely have a domino effect causing other Multi-Strats into forced liquidation as well. A big part of the business model is an extreme aversion to even small losses due to the leverage and netting risk inherent in the business. Even a minor reversal of crowded positions may cause rapid delveraging which would have spillover effects. We witnessed a whiff of this in March, 2020 when there was an unwind of the Treasury Basis trade and the Carry Trade. The US Treasury and Fed came to the rescue toward the end of March adding liquidity to the system to stem the carnage and many Funds had miraculous comebacks as a result by month-end.
At a time when the appetite for Multi-Strats is seemingly unsatiable, we wanted to highlight that this strategy is not without it’s risks despite prior performance which often spans multiple decades. There has never been more capital invested in Multi-Strats which changes the risk profile and market impact more than ever before. With that said, we remain invested in Multi-Strats however, we have pared our exposure to the 2nd and 3rd tier Multi-Strats (defined by AUM) for these reasons coupled with fierce competition for talent are often won by the largest Firms given their technological capabilities, infrastructure, proven history, and seemingly unlimited capital to allocate to the brightest PMs. Hard to compete against that.
Neal Berger President Eagle’s View Capital Management 212.421.7300
