Eighteen months ago, finance experts believed the hedge fund industry was losing power as a global player in the finance world. So much so that according to Tabby Kinder, the Hedge Fund Standards Board was “debating a name change in an effort to distance itself from a term that [had] become increasingly contentious.”
But that was last year. A lot can change in 12 months and today the hedge fund industry is bouncing back. Rob Copeland wrote in a WSJ article:
“The average hedge fund is up 5.4% … while stock-focused hedge funds have gained 8.31%, [and] Standard & Poor’s 500 rose 11.9% including dividends, while the traditional 60-40 split of stocks and bonds would have earned 8.9%.”
Looking more closely at the winners in this hedge fund revitalization we see New York hedge fund Brahman Capital. Copeland explains the story of Brahman Capital Corp’s rise of its “big bet on hedge-fund favorite Valeant Pharmaceuticals” that initially plummeted, resulting in Brahman’s own fall with investors taking their money out. But then Brahman came back, selling the stock “and with what is now $3.8 billion of remaining cash pivoted to new ideas…[Today], Brahman’s main fund is up 17%.”
Copeland’s conclusion that “the gloom that had beset hedge funds [a couple of years ago] is [now] lifting and even giving way to outright optimism.” Indeed, according to Pacific Alternative Asset Management Co partner Alper Ince, “it just feels better” and if Brahman Capital’s example is anything to go by, Ince’s words lead us to believe that the reality of hedge funds today is closer to revitalization than a near demise.
Hedge fund executives were a different breed in the 1980s and 1990s to what they are today. Back then, hedge fund executives were working within a “culture of tough guy traders.”
Paloma Partners founder Donald Sussman recalls how in 1998, 37-year-old Columbia University computer science professor David Shaw – who had been working at Morgan Stanley with a “new secretive trading group that was using computer modeling” – asked for his opinion on an offer he had received from Goldman Sachs.
“Sussman’s career has been built on recognizing and financing hedge-fund talent, but he had never encountered anyone like David Shaw. The cerebral computer scientist would go on to become a pioneer in a revolution in finance that would computerize the industry, turn long-standing practices on their head, and replace a culture of tough-guy traders with brainy eccentrics — not just math and science geeks, but musicians and writers — wearing jeans and T-shirts.”
Shaw – and partner Peter Leventhol – “convinced [Sussman that] they could generate models that would identify portfolios that would be market-neutral and able to outperform others.” In other words, a large amount of money would be made generating minimal risk.
Sussman recommended Shaw rejecting the Goldman Sachs’ offer and Paloma Partners made a $30 million investment with D.E. Shaw. Today the company “has grown into an estimated $47 billion firm, earning its investors more than $25 billion — as of the end of 2016, tied for the third biggest haul ever.”
This is more than just a story about a successful company. It has resulted in a “quantitative revolution [which] has become the biggest trend in hedge funds today, capturing some $500 billion of the industry’s more than $3 trillion in assets and dominating the top tier. Seven out of the top ten largest funds are considered ‘quants,’ including D.E. Shaw itself.”
The massive transformation of strategy has resulted in a situation in which it has become “cheaper and easier for all investors to get into the game, leading to an explosion in trading volume.”
And that can be dated back to a preliminary chat Donald Sussman had with David Shaw in 1998.