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James Williams | editor in chief | Hedgeweek, FIS
November 20, 2020
Some of the industry’s leading multi-strategy hedge fund managers have had a good year so far, with their ability to trade myriad asset classes across the liquidity curve enabling their portfolio managers to harvest numerous sources of alpha.
Swedish hedge fund Brummer & Partners, for example, saw its flagship Brummer Multi-Strategy (BMS) Fund return 4.2 percent through August, locking in positive performance in equity, credit and fixed income funds. Similarly, its 2x levered version was up 7.3 percent for the same period.
Multi-strategy harness the brain trust of multiple investment teams, or pods, with the portfolio manager at the helm and responsible for their own P&L.
Israel Englander’s Millennium Management operates four distinct strategies, Citadel has built a platform spanning five asset classes and at Balyasny Asset Management, the firm’s evolution from a single equity long/short strategy to a global mandate covering equities, macro, event and credit seems to be working well. As the Financial Times recently reported, Balyasny’s Atlas Enhanced Fund was up 23 percent through August.
Overall, multi-strategy rules the roost in 2020, having returned 10 percent, on average, through September 2020, according to the HFRI Multi-Strategy Index.
“We’ve seen this year that some of the industry’s top-performing strategies are the large multi-strategy shops such as Exodus Point, who have grown their AUM by 30 to 40 percent and delivered very good returns,” comments Adrian Holt, head of hedge fund strategy at FIS.
This would appear to be a favorable period for these big platform-like institutions, against an uncertain global macro backdrop, higher market volatility and the potential for more asset class dispersion. The question for single-strategy hedge funds is: ‘Can we evolve our business and diversify to attract more investors?’
Scaling your operations is never an easy undertaking, but technology is now beginning to change the way managers think about diversification.
The value proposition of the blue-chip managers referenced above is the risk management overlay they place on each portfolio manager within the group, ensuring there are strict risk controls which can be dialed up and down as and when needed.
But as Holt explains, “To do this requires having sophisticated risk management capabilities on the hedge fund platform. The profile of hedge fund investors has become much more institutional and the benchmarks they put in place for a hedge fund to be eligible are very high. This means more capital flows towards the largest hedge funds, who can demonstrate high levels of governance to give investors the confidence they need. This includes robust risk management oversight on each portfolio manager.”
Single-strategy hedge funds rely on one or two star managers, who will often be the founders of the firm. Michael Hintze at CQS and Alan Howard at Brevan Howard have both redoubled their focus on trading recently.
The industry is peppered with tremendous high-quality, single-strategy managers, but they represent significant idiosyncratic risk from an investor’s perspective. It only takes one bad year of returns for an investor’s risk appetite to wane, unlike a multi-strategy hedge fund that can quickly change to bring on new managers and new investment ideas. This helps to diversify the risk, as it is spread across numerous strategies, not just one or two.
“Large multi-strategy funds can be viewed as a one-stop shop for investors to access a variety of strategies,” comments Trevor Headley, head of hedge fund product management at FIS. “We’ve noticed a shift, in terms of the gravitational pull the large multi-strategy managers can exert to attract more investment dollars.”
Headley explains that for single-strategy managers considering how to operate at scale across a number of asset classes, it is important to have systems that are able to handle that diversity, and provide the flexibility to support strategies that operate at a higher transaction volume than others.
“Another consideration is the variety and number of different counterparties the manager might be trading with; being able to have a technology platform with an open data model is vital. As new prime brokers or custodians are introduced, you need to be able to manage those counterparties efficiently.
“Having an open architecture becomes key to realizing transformational change,” states Headley.
As hedge funds expand the scope of their investment activities, it introduces layers of complexity that need to be managed to avoid issues for risk, compliance, ongoing collateral management and so on. It can quickly become burdensome if the manager is relying on a monolithic system. That might have been fine for handling a discretionary equity long/short strategy, but it’s ill-equipped for a more quantitative trading style.
Regardless of what the diversification objectives are, managers should consider a platform infrastructure that can integrate numerous investment strategies and still present a single, holistic view; think of it like a Russian doll.
“I saw a great picture recently of the operations room inside a well-known hedge fund and it looked like NASA’s mission control room. They have a series of dashboards showing P&L and risk exposures across all of the strategies they are running. To do that, you need a technology platform that can consolidate everything and present a single view of P&L, risk and positions across every strategy,” says Holt.
He adds that it is naïve to think that one system could cover every conceivable trading strategy but at the very least, “what you need is a central core framework that has the potential to be extended and customized.”
“Key to this is having an open API-driven architecture, where you can plug in other best-of-breed systems, rather than expecting to have one monolithic architecture than can handle every asset class,” says Holt.
The importance of an API-driven architecture is to break away from the monolithic platform approach and use APIs to introduce data sets and services, each of which is designed to do one thing very well; for example, performing valuations on complex credit instruments.
To continue the ‘Russian Doll’ analogy, each system works to support the manager trading a specific asset class, but does so in a way that fits in to the overall platform architecture. This provides the technology bedrock necessary to achieve that NASA-like mission control view of the portfolio at a firm-wide level.
“Being able to pull together purpose-driven services and solutions allows both the portfolio managers and their technologists to harness the full power of the platform. Doing it in an open way can really supercharge that process; this is where technology becomes an enabler.
“Large multi-strategy hedge funds are able to knit different solutions together using their own technology to get that holistic view across different asset classes and trading strategies,” says Headley.
For smaller hedge funds who might previously have thought that scaling up to become, potentially, the size of Cerberus or Millennium Management was impossible, today’s platform technology capabilities are changing their expectations of what is possible.
“Technology is leveling the playing field. We give managers the glide path to diversify, depending on where they are in their growth cycle. They have the comfort of knowing they have a future-proof solution that can support them as they decide to move into new asset classes,” concludes Holt.
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