The hedge fund industry is in turmoil.
Tony James, COO of the alternative investing giant Blackstone, ran through some of the challenges facing the industry on an earnings call on Thursday June 21.
It isn’t the first time the billionaire has talked about the challenges facing the industry. He said in May that hedge funds could lose as much as 25% of their assets.
And on this occasion, he provided a perfect summary of why the hedge fund industry is struggling. Here is James:
Frankly we expect to see assets move from human managers to machine managers. We also expect to see assets moving from high fee managers to lower fee managers or lower fee vehicles. And in some cases, assets moving from vehicles with lots of liquidity to assets with less liquidity. But I do think, I think fundamentally, when you have an industry which has underperformed the market averages and charges 2 and 20, there is going to be a lot of fee pressure on a lot of managers.
Let’s unwrap that a little.
First, the hedge fund world is increasingly reliant on computers and mathematical models, as opposed to human traders. Institutional Investor in May released its annual list of the top-earning hedge fund managers, and six of the top eight were quants, or managers who rely on computer programs to guide their investing.
Second, there is a move towards
lower-cost alternatives, such as liquid alternatives funds, as they provide hedge fund-like investments with lower fees. That has the potential to draw assets away from hedge funds.
Third, with interest rates so low, investors are having to move to less liquid areas of the market to find returns. That includes things like direct lending, real estate and distressed debt.
hedge funds charge hefty fees — typically 2% of all assets, and 20% of profits — in return for beating the market. That hasn’t happened though, prompting disappointed investors to turn up fee-cutting pressure.
Blackstone itself has been impacted by these challenges. Blackstone’s hedge fund unit saw a 1% increase in related fees revenue and a 1.4% gross return, according to second quarter results.
Overall, the hedge fund industry’s return was at 1.6% through June, according to Hedge Fund Research. That’s less than half the gains in the S&P 500.
Blackstone’s $1.9 billion hedge fund Senfina Advisors has lost 15% this year, Bloomberg reported. That was largely dragged down by “stock-specific movements uncorrelated to Brexit,” which led to a 3.5% decline in June.
Overall, Blackstone beat expectations with a 2% jump for its second-quarter profit, driven by strong real estate sales and credit returns. Its economic net income, which measures unrealized and realised investment gains, was $520 million in the three months ending June.
Blackstone now manages $356 billion in assets, a 7% jump on the year, according to the company’s results. Other alternative assets management firms, KKR & Co., Carlyle Group and Oaktree Capital Management, will report results next week.