Evaluating a traditional hedge fund was once reasonably straightforward.
You'd talk with the chief investment officer and a few senior staff, review its trade history, debate its risk-management philosophy, and maybe push it to lower fees. It was typically more about understanding the firm's strategy — and there are plenty of esoteric ones in hedge-fund land — than the structure of the firm itself.
The rise in multi-manager hedge funds over the past five years has forced allocators to create a separate due-diligence model for these types, which make up one of the fastest-growing segments in the industry. Funds like Ken Griffin's Citadel and Izzy Englander's Millennium have hoovered up assets and talent, and upstart alternatives and smaller peers are growing fast.
These funds, which combine teams across the world trading different strategies into a single portfolio, have seen their assets grow to nearly $690 billion industrywide, according to BarclayHedge, a jump of 93% since the end of 2020.
For those looking to write big checks to hedge funds, their due diligence focuses on the ecosystem these platforms have created and their expenses, which are not as simple as a typical fixed management-and-performance fee. Even smaller, relatively unproven options are charging clients a pass-through fee — which gives funds almost a blank check to charge LPs for expenses — and 20% of profits while also barring withdrawals for several years.
The evaluation, allocators say, needs to focus on the C-suite and how they manage expenses, not the top money-makers at the firm. This is similar to how a Fortune 500 company is evaluated: by examining the CEO and its board.
It's another shift toward seeing hedge funds as more institutional players, leaving allocators feeling almost like sell-side analysts. Funds have become "skill factories" and successful ones have been able to "industrialize skill" and diversify away from relying on a single star, said Jack Springate, cohead of the $28 billion hedge-fund investor at Goldman Sachs Asset Management.
In practice, this means allocators are talking to the people managing the portfolio managers "who pull the trigger on trades" instead of the actual investors themselves, said Allen Cheng, who leads a team of hedge-fund researchers for Aon.
"What you're really evaluating is their ability to retain and recruit people who are good at pulling the trigger," Cheng said. "You have to have a really good recruiting team. You have to understand the appeal of one firm versus another."
Put more bluntly by one European allocator: "We're all just comparing recruiting firms."
Compared to dissecting old-school managers, Cheng said, "It's a little bit corporate." Even an executive at a midsize multi-manager admits that their firm and its peers are "more like corporations than hedge funds."
"It's becoming an asset class in and of itself," this executive notes.
A new type of hedge-fund kings
Typically, the founders of new funds were the best traders and money-makers who spun out of banks' trading desks and larger hedge funds. But for platform founders, the pitch is now more corporate.
Bobby Jain, the former Millennium executive who started his own multibillion-dollar hedge fund, hasn't traded in decades but was a part of the leadership team at one of the biggest hedge funds in the world. When the ExodusPoint cofounder Michael Gelband left Millennium in 2017, his parting email did not list his top trades. It did, however, reference the billions in revenue the fixed-income group made under his purview.
Dmitry Balyasny stopped trading his personal book in 2022, sources say, as he focused more on management. Steve Cohen has spoken about increasing his time mentoring the next generation of traders and has a cochief investment officer, though he is still running a portfolio at Point72.
Izzy Englander is no longer the sole chief investment officer of Millennium, instead creating a whole separate "office of the CIO" branch to monitor risk and strategies across his sprawling firm. Millennium also named Ajay Nagpal, the firm's chief operating officer, as president around the same time in 2022.
The billionaire septuagenarian's note to investors in 2022 said that the reorganization was necessary, "given the size and scale of our business, as well as our diversification and the prospects for future growth."
The change isn't just happening at Millennium. Jobs at multi-manager funds are roughly a quarter of the industry's overall roles, despite these platforms holding only about 14% of the industry's total assets. Back-office teams responsible for accounting, recruitment, and admin at the largest firms can have hundreds of employees.
Not everyone will be a winner
"Evaluating the mousetrap" takes precedence over evaluating a platform's roster of PMs, said Kevin Lyons, a senior investment manager at Abrdn, who allocates to hedge funds.
It's the "foundation and support" of these firms — not the current traders in their seats — that are most important, he said. When speaking with platforms Abrdn doesn't already have a relationship with, 90% of their time is spent speaking with the business-development and risk teams, Lyons said.
For business development, "we want to know what the characteristics of PMs who have been successful on the platform and the characteristics of PMs who haven't been," Lyons said. On the risk side, he wants to understand "how does it all roll up into a single portfolio?"
Because the reality is "not every multi-manager deserves a pass-through and 20," Lyons said. It's his job to be someone who picks the winners and losers.
Now that the risk-free rate — which is the return an investor would get by just parking money in US Treasury bonds — is above zero, these multi-manager funds have to make money. A stretch of poor performance coupled with increasing costs can pull even the strongest firms down. Schonfeld's near-takeover by Millennium and subsequent cost-cutting moves were a prime example of how quickly a downward spiral can form.
Now, new platforms are popping up across geographies while the mid-tier players game out how to grow — in order to expand their business and also just survive.
"It's not one-way traffic up," Springate said.
"You're going to see more dispersion in the institutional part of the hedge fund industry."
