Hedge Fund Poll: The world’s best hedge fund managers

JIM SIMONS, FOUNDER of quant shop Renaissance Technologies, is about as far removed as can be from the hackneyed image of the egotistical flashy hedge fund manager. He is in his late 60s, shuns the limelight and admits he knows very little about the hedge fund industry. Calm and thoughtful, he just does his job and has a team of very smart people working with him. If he left tomorrow, the firm could run just as well without him, he modestly suggests.

It’s clear, though, that many of the world’s biggest investors in alternative funds don’t share his view. Asked to name the individual that they considered to be the most talented manager working in the hedge fund industry today, Simons is the clear winner. His nearest challengers – Christopher Hohn of The Children’s Investment (TCI) Fund and Stephen Cohen, founder of SAC Capital – are also two of the best-known hedge fund managers in the business.

In fact, their individual reputations even exceed those of their firms. Renaissance is ranked second behind Lansdowne Partners (see profile) as the preferred long/short equities fund; Atticus pips TCI to the choice of dream event-driven manager.

Reputation and name recognition clearly count high on the list when investors choose start up firms. Philippe Jabre’s Jabre Capital Partners was named by respondents as the best start-up fund. Jabre formerly worked for GLG Partners, but was fined £750,000 ($1.54 million) for trading on inside information by the FSA in 2006, and left GLG Partners. Since then, Jabre has established himself in Geneva, setting up his own fund. Investors have reportedly handed over more than $3 billion in assets to Jabre based on his success rate in his initial years at GLG Partners. Jabre Capital Partners already ranks in the top five convertible bond arbitrage funds, according to the survey.

Simons’ background is academia. The son of a shoe factory owner in Massachusetts, he studied mathematics at Massachusetts Institute of Technology, where he later taught. After leaving teaching in 1978, Simons ran a fund before setting up quant shop Renaissance Technologies in 1989. Renaissance’s offices out in Long Island, New York, have even been compared to a college campus.

Using constantly tweaked computer models, Renaissance’s Medallion Fund has produced net annual returns of 37%, and as a result has been able to charge some of the highest fees in the industry. With assets now exceeding $6 billion, most of the money invested by third parties has been returned, and it is being run as a proprietary fund. Last year, the firm launched Rief, a long-only fund designed to handle more than $100 billion in assets.

Simons’ achievements at Renaissance have made him not only a legend but also one of the wealthiest men in hedge funds – he earned an estimated $1.7 billion in 2006. He uses his wealth to fund several philanthropic pursuits that he regards as a second job. Among many other causes, Simons has focused funding on research into solutions to autism. Having committed $38 million to the area, he plans to spend a further $100 million appointing a team of scientists to work on the project.

Jim Simons, Founder of quant shop Renaissance Technologies

What hedge fund investors want  One of the key attributes to being a successful manager of other people’s money, aside from producing consistent excess returns, is to understand the needs and concerns of clients.

Hedge funds are estimated to hold upwards of $2 trillion in assets, a clear indication that this alternative class has planted itself firmly in the consciousness of investors worldwide. As the industry has evolved, concerns about fraud have subsided to be replaced by the challenge of continuing to produce the double-digit returns that spurred the initial appetite for hedge funds. As investors become more sophisticated in their ability to select managers, their views on the industry have also become more important.

Euromoney polled a selection of investors, including banks, funds of hedge funds, family offices, high-net-worth individuals, insurance companies, endowments and pension funds, and government organizations, to find out which managers they believe are excelling in their field and to identify their concerns about the future of the industry.

As part of the survey, participants were asked to rank the most important factors apart from performance that influence their investment decisions. Risk management and transparency in reporting were the only factors to be regarded by the majority of respondents as being as “very important”. Philosophy, style drift, future capacity, management pedigree, lock-ups and efficient liquidity management, research and back-office and supporting counterparties were all considered by the majority of respondents as “important”.

Little fear of fraud

Of the chief concerns about hedge fund investing expressed by respondents, it is comforting to see that fraud was mentioned by only one participant. It’s an indication that the industry has been successful in shedding the cowboy image with which it was initially tarnished, and of its maturation. At the same time, it suggests that investors feel that they are carrying out sufficient due diligence on managers and have eliminated the possibility of fraud in their hedge fund portfolios.

Apprehensions expressed most frequently by respondents focused on increasing fees, leverage levels and managers becoming too much alike in their strategies.

In most industries, a larger number of players would put downward pressure on fees. But that is not the case in the hedge fund industry, if you have proved your worth. Although the standard fee structure of hedge funds is a 2% management fee and 20% performance fee, maturer managers that boast long-term double-digit performance have been raising their fees, in some cases to as much as 5% and 50%. Although it could be argued that fee levels are irrelevant so long as the net returns that investors receive are in line with or better than expectations, increases in fees tend to rile investors. Other than a perception that managers are being greedy, it is not clear why investors are so vehemently opposed to higher fees. If net returns are the same in spite of fee increases, it cannot be a cost issue. Furthermore, respondents that highlighted fees as a chief concern ranged from those with less than $25 million invested in hedge fund assets to those with more than $1 billion invested, supporting the theory that this is not an issue of affordability.

One fund of hedge funds manager comments: “We all know hedge fund managers get paid too much, and when managers charge more than the 2 and 20, it is going to get investors’ backs up. We personally, however, do not look at fees. So long as a manager is producing the returns for which we employed him, we cannot complain.”

The amount of leverage being used by hedge fund managers was highlighted by respondents as of equal concern as fee increases. One respondent says: “Leverage is definitely a concern when risk aversion approaches lower historical bounds.” Another investor says that use of leverage by potentially unsophisticated managers is a cause for concern for the entire industry.

Just how much leverage hedge funds as a whole are using is a subject of debate. The amount used today is lower than it was before the LTCM blow-up in 1998, though industry reports suggest that levels are creeping up. A research paper by Bridgewater Associates in April suggested that leverage was at levels last seen in 2001. A note released by ratings agency Fitch in June says that prime brokers admit to continued pressure to provide more relaxed credit terms to hedge funds through higher leverage because of growing competition to attract hedge fund clients. The note adds that most hedge funds were reported to be financing their positions at levels well below the maximum leverage permitted by prime brokers (about 40% to 60% of the maximum allowable), but that these levels could in effect be higher given the growing use of credit derivatives, which makes it hard to measure leverage. Indeed, several of the respondents voiced as their chief concerns the growing use of complex instruments by hedge funds. One respondent lists as her chief concerns: “Leverage, extensive use of credit derivatives and valuation of illiquid instruments.” A small percentage of respondents mentioned the sub-prime market as being worrisome.

More players produce challenges

In terms of the biggest challenges facing the hedge fund industry, respondents were in agreement on several topics. The most frequently voiced challenge pinpointed was correlation. Hedge funds in their true sense are supposed to produce returns irrespective of equity market or debt market movements, yet investors say that correlation is becoming an issue. Several investors stressed the need for managers to “stay clear of equity market risk” and “to eliminate the increasing correlation with traditional assets”.

The over-arching driver of the top five challenges mentioned by correspondents appears to be the increasing number of funds. One investor says: “There are too many funds, and it calls for consolidation.” Another says: “There are too many companies involved now [and that is going to lead to] competition.” As the number of participants continues to grow, issues of capacity restraints and ability to find alpha will place heavy demands on hedge fund managers. One respondent says: “[As an investor,] finding talented alpha generators that manage to perform despite the huge influx of capital into the industry will be the biggest challenge.” Capacity constraints and the identification of alpha-producing areas that have yet to be arbed away by other managers will put pressure on returns, say investors. Hedge funds’ ability to produce returns that meet the expectations of investors will be among the top five challenges, the survey reveals.

Investors say that in addition to growing competition from their own peers, managers will now have to overcome competition from mutual funds and traditional asset managers. Several respondents commented on one emerging competitor – the 130/30 fund, which goes long 130% and short 30%. “Alpha creation compared with 130/30 funds and long-only funds [is the biggest challenge for hedge funds],” says one investor. Another adds: “The introduction of Ucits III and 130/30 fund structures [will be challenging].” According to a study released by Vodia Group in June this year, the top managers of 130/30 and 120/20 funds have only $50 billion in assets, compared with the $2 trillion in hedge fund assets. The concern, however, is that firms running 130/30 funds are well-established asset managers with large infrastructures and investor networks that would allow them to gather assets faster than hedge funds.

Providers of 130/30 funds will also be less affected by regulatory changes than hedge funds. Pressure from regulators was listed by more than 10% of respondents as being a threat to the future of hedge funds.