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Tuesday, March 31, 2015

Bloomberg: Here Comes a New Wave of Billion-Dollar Hedge Funds

Here Comes a New Wave of Billion-Dollar Hedge Funds

(Bloomberg) -- Hedge fund investors aren't giving up just yet. 

At least five new hedge fund companies are on track to start with at least $1 billion this year, according to data compiled by Bloomberg, after eight firms started with a 10-figure sum last year. The industry hasn't seen this many mega-startups since 2005, when 13 funds raised a combined $19 billion. 

Frustrated with the mediocre performance of some of the industry's old guard, investors hoping for higher returns are writing checks to a handful of new funds, including one run by Brevan Howard Asset Management veteran Chris Rokos and another headed by ex-Elliott Management Corp. star Didric Cederholm. 

"Most hedge funds aren't any good, but if you can identify talent early, when they are hungry, you have the potential to generate outsized performance," said Adam Blitz, chief investment officer at Evanston Capital Management, which invests $5.4 billion in these private partnerships. 

These new managers are beneficiaries of the poor performance of some established multi-billion-dollar firms, such as John Paulson's Paulson & Co., Carlyle Group LP's Claren Road Asset Management and Mason Capital Management -- which have either lost money or failed to make any over the last three years -- and the generally sluggish returns for the industry overall. 

Fund Performance 

Hedge funds on average climbed 4.6 percent annually over the past three years, according to data compiled by Bloomberg. That's about three times the return of U.S. government debt yet far below the 18 percent gain of the Standard & Poor's 500 Index. At least one large investor, the California Public Employees' Retirement System, said it would exit its hedge fund investments, citing the costs and complexity. 

The University of Texas Investment Management Co., which oversees money for the U.S.'s second largest university endowment, is one of the biggest backers of the new startups. It already has about $2 billion invested with what it calls "next generation" firms "with the objective of sustaining top-decile performance for years to come," Bruce Zimmerman, the endowment's chief executive officer, wrote in an annual report published late last year. He didn't return calls seeking additional comment on his new investments. 

The new breed of managers tends to be seasoned professionals who have worked for years at larger firms, where they were proven money makers. They have been able to raise large amounts by getting big commitments from a few investors, mostly without having to give up any part of the equity in their firms to do so. 

Ziff Alumni

Four of the managers who started billion-dollar firms since the beginning of last year came out of the Ziff Brothers family office, which managed the wealth of Dirk, Robert and Daniel -- scions of William Ziff's magazine-publishing empire. The brothers began reorganizing how they manage their fortune after several key managers left. 

David Fear, who ran the Ziff's London office, started trading at his Thunderbird Partners this year with $1.5 billion, according to a regulatory filing, and he chose to stop accepting any more money for the time being, said people with knowledge of the firm. His investors include the Ziff brothers, the University of Texas endowment and Charlottesville, Virginia-based Investure, an endowment money manager, according to the people, who asked not to be named because the firm is private. 

Soros Check

Isaac Corre is getting at least one big check from a large investor. He's opening his New York-based Governors Lane to focus on event-driven investing in the next few months. George Soros's family office is putting in as much as $500 million, according to people familiar with the firm. Corre comes from Eton Park Capital Management, the hedge fund firm run by Eric Mindich, who himself was among the biggest startups ever, amassing $3.5 billion out of the gate in 2004. 

Bankers expect that Rokos, who generated more than $4 billion as a trader at Brevan Howard, will raise billions when he starts his own firm later this year. Rokos recently settled a legal battle with his former boss, Alan Howard, over whether he could manage money for outside clients before 2018. As part of their settlement, Brevan, which posted its first loss last year, will have a financial interest in the yet-unnamed firm. 

Some of the managers have come out of successful firms that limit the amount of money they take in, helping to spur interest in their alumni. Cederholm focused on fixed income and distressed investments at Elliott, which only periodically opens for new investments. 

Lion Point

Cederholm is starting Lion Point Capital next month, according to a filing with the Securities and Exchange Commission. The firm will focus on buying and selling stocks, bonds, bank loans and other securities of companies going through corporate events including bankruptcies and restructurings. 

Executives from the firms didn't return calls seeking a comment or declined to comment. 

Investors have enthusiastically backed new funds before only to be disappointed.

Arvind Raghunathan, former head of Deutsche Bank AG's global arbitrage business, started his Roc Capital Management in July 2009 with more than $1 billion, only to return client capital four years later because of losses.

Pierre-Henri Flamand, a former Goldman Sachs Group Inc. proprietary trader, flamed out even more quickly. He opened his Edoma Partners in 2010, immediately raising $2 billion. Poor performance forced him to close shop just two years later.

Yet clients continue to seek out the next superstar.

"Finding that young talent is always at a premium," said Evanston's Blitz. "You are seeing household name hedge funds becoming big institutions -- it might be good for business but not for investors looking for differentiated returns." 

To contact the reporters on this story: Katherine Burton in New York at kburton@bloomberg.net; Simone Foxman in New York at sfoxman4@bloomberg.net

To contact the editors responsible for this story: Christian Baumgaertel at cbaumgaertel@bloomberg.netPierre Paulden, Sree Vidya Bhaktavatsalam

Affiliated Managers Group Mutual Funds With Adaptive Allocation Delivered Big Returns With Low Volatility


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Summary

  • A portfolio of two AMG mutual funds plus a Vanguard bond fund managed with an adaptive allocation strategy delivered over 10% annual return over a 17-year period.
  • This portfolio comprised of a high quality bond fund, a large value income fund and a high volatility small cap growth fund exhibited extremely low volatilities and drawdowns.
  • Adaptive allocation with low volatility target produces results suitable for conservative investors while the portfolio may have components that are considered suitable only for aggressive investors.

The three mutual funds considered for investment are the following:

  • Vanguard Intermediate - Term Treasury (MUTF:VFITX)
  • AMG Managers Bond Service (MUTF:MGFIX)
  • AMG Managers Skyline Special Equities (MUTF:SKSEX)

This article is part of a series dealing with the major US mutual fund families. Most of the previous articles were applied to the largest families with huge asset investments, such as Vanguard, Fidelity, T Rowe Price, PIMCO, etc. AMG is a mid size family with only 88B in net assets. Because AMG does not have any high quality bond fund, I decided to include a bond fund from Vanguard. As we did many times before, three different strategies will be considered:

(1) Fixed Allocation - Portfolio is initially invested 30% in VFITX, 30% in MGFIX and 40% in SKSEX without rebalancing.

(2) Target Allocation -Portfolio is initially as above but with re-balancing when the allocation to any fund deviates by 10% from its target.

(3) Adaptive Allocation -Portfolio is invested dynamically among the three funds based on a variance-return optimization algorithm developed on the Modern Portfolio Theory (Markowitz). The allocation is rebalanced at fixed two-month intervals at close of the first trading day of the month.

Basic information about the funds was extracted from Yahoo Finance and is shown in table 1.

Table 1

Symbol

Inception Date

Net Assets

Yield%

Category

VFITX

10/28/1991

5.63B

1.65

Intermediate-Term Bond

MGFIX

6/01/1984

3.05B

5.18

Large Growth

SKSEX

9/25/1997

1.40B

0.00

Small Growth

The results reported in this article cover a period of 17 years between March 1, 1998 and March 2, 2015. The starting day was selected based on availability of historical data of the three funds by adding a period of 65 trading days for initial estimation of the parameters used for optimization.

In table 2 we show the buy-and-hold results of investing in each fund.

Table 2.

Symbol

TotReturn%

CAGR %

maxDD%

VOL%

Sharpe

Sortino

VFITX

152.42

5.55

-6.66

5.13

1.07

1.72

MGFIX

198.82

6.60

-23.65

5.18

1.27

1.67

SKSEX

332.94

9.08

-65.28

21.70

0.42

0.55

SPY

191.41

6.44

-55.18

20.40

0.32

0.41

Here are some observations about the performance of our two AMG funds. MGFIX was a relatively good choice by itself since it delivered slightly higher return than SPY, had a bond like volatility of only 5.18% and a maximum drawdown half that of SPY. SKSEX, on the other hand, was a good choice only for extremely aggressive investors: it produced annually on average 2.50% more than SPY, but with higher volatility and a huge 65% drawdown. As we shall see, the adaptive allocation strategy is able to produce even higher returns while reducing the maximum drawdown and volatility to level acceptable to most conservative investors.

In table 3 we show the simulation results for the portfolios from April 1, 1998 to February 28, 2015. We applied five strategies:

  1. Fixed equal weight allocation
  2. Target allocation with rebalancing when an allocation deviates by more than 10%.
  3. Adaptive allocation for a LOW volatility target
  4. Adaptive allocation for a MEDIUM volatility target
  5. Adaptive allocation for a HIGH volatility target

Table 3.

 

TotRet%

CAGR%

NO.trad

maxDD%

VOL%

Sharpe

Sortino

Fixed allocation

242.55

7.45

0

-30.62

7.93

0.94

1.31

Target allocation

274.32

8.01

30

-31.44

8.53

0.94

1.28

Adapt. allocation LOW

360.06

9.46

101

-8.36

6.68

1.42

2.01

Adapt. allocation MED

425.99

10.34

101

-12.27

8.35

1.24

1.56

Adapt. allocation HIGH

521.03

11.43

101

-13.04

9.78

1.17

1.56

As can be seen in table 3, the adaptive allocation with a low volatility target realizes the highest risk adjusted returns, i.e. the highest Sharpe ratio.

In figures 1 and 2 we show the graphs of the portfolio equities.

(click to enlarge)

Figure 1. Equity curves for a fixed allocation portfolio with no rebalance (brown), a portfolio with fixed targets and rebalancing at 10% deviation (green), and a portfolio with adaptive allocation with LOW volatility target.

Source: This chart is based on calculations using the adjusted daily closing share prices from finance.yahoo.com.

(click to enlarge)

Figure 2. Equity curves for three portfolios adaptively optimized with a low (NASDAQ:BLUE), medium (brown) and high (green) volatility target.

Source: This chart is based on calculations using the adjusted daily closing share prices from finance.yahoo.com.

In figure 3 we show the time variation of the percentage allocation of the three funds with a low volatility target.

(click to enlarge)

Figure 3. Portfolio allocation for a low volatility target.

Source: This chart is based on calculations using the adjusted daily closing share prices from finance.yahoo.com.

The current allocations for March and April 2015 are given in table 4.

Table 4

Volatility Target

VFITX

MGFIX

SKSEX

LOW

57%

0%

43%

MID

46%

0%

54%

HGH

35%

0%

65%

Conclusion

This article demonstrates that one can successfully combine funds from different families in order to achieve specific goals. Also, it shows that it is not important to use the best performing funds in the construction of good portfolios. The adaptive allocation strategy is able to produce higher returns than the most volatile component while reducing the maximum drawdown and volatility to levels acceptable to most conservative investors.

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Comments (3)
  • Robin Heiderscheit
    Comments (2044)| Send Message
     
    In 1998 10 yr corporates yielded 750 bps. What do you do for an encore with 10 yr corporates yielding 350 bps? 
    10 Mar, 09:57 AMReplyLike0
  • Toma Hentea 
    Contributor
    Comments (98)| Send Message
     
    Author's reply » The strategy adapts to the market environment. You may look carefully at figure 3 to see how it allocated during different stages. Even in 1988 it allocated mostly in treasury bonds. Same in 2002, 2007-09 and the most recent 3 months. 
    10 Mar, 10:34 AMReplyLike0
  • Robin Heiderscheit
    Comments (2044)| Send Message
     
    I apologize since my comment really wasn't related to your very thoughtful argument. The reallocation strategy seems like it could continue to outperform certain bench marks . . . my only point was that from here, reaching 10% a year is a pipe dream.

     

    Good article! 
    10 Mar, 11:16 AMReplyLike0
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