Ken Griffin's guide to viable hedge funds
Leaving a job as a trader in a bank for a job as a portfolio manager with a hedge fund can be a risk. Ask those who have walked the path and encountered a cliff edge drop, sometimes through no fault of their own.
At the level of the individual portfolio manager, hedge fund career security depends mostly, but not exclusively, on individual P&L. Funds like Millennium famously operate a system in which if you lose 5% of the money allocated to you, your capital allocation will be halved. If you lose 7.5%, you will be out.
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But the fund you work for needs to perform, too. Multistrategy hedge funds employ portfolio managers working across investment strategies with the intention of producing uncorrelated, diversified returns that always beat the market. If a fund's overall performance is poor, it won't survive. Take Eisler Capital.
It's not necessarily enough simply beat the indices, though. Speaking to Goldman Sachs yesterday, a tanned Ken Griffin said that for hedge funds to entice investor money to "flow in," they need to be generating returns equivalent to the risk free cost of capital, plus 4%. "Long run, we think that's the equilibrium point," said Griffin. A fund that generates returns in excess of this, will have no trouble attracting investors.
The risk free rate is defined in terms of the rate that's paid on US Treasury bills. The yield on 10 year Treasury notes is currently 4.55%. Under Griffin's reasoning, hedge funds therefore need to be generating returns in excess of 8.55% to keep investors happy.
Some funds are doing this and more. Marshall Wace's Eureka fund returned nearly 20% in the first half of the year, for example. Citadel's own tactical trading fund returned 14.3% over the same period.
However, Citadel's Wellington Fund only returned 5.7% in the first half of this year. Jain Global returned only 3.9%; Balyasny returned only 2.6%; Brevan Howard's Master Fund returned only 2.23%; and Taula made a loss of 3.1%.
None of this is likely to be significant in the immediate term Griffin was talking about the long run, not six months and not even a year. It's also worth noting that most funds operate multiyear lock-ups to prevent investors withdrawing money after a period of poor performance. Locking investors in for four or five years is common.
Even so, Griffin's threshold figure of circa 9% is interesting. If you work for a hedge fund that doesn't meet this threshold one year, you're probably fine. If it doesn't the next then year, then you're probably still fine. But if the fund goes into years four or five with returns below 9%, then the screws will be tightened. You probably don't want to leave your cosy banking job for a fund like this.
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