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Hedge fund industry growth 'unwelcome', says Caxton's Law

Thursday, September 15, 2016 - 07:45

[NEW YORK] Andrew Law said the hedge fund business is too big - and failing.

Mr Law, who runs Caxton Associates, said the growth in industry assets since the global financial crisis has been "both an exceptional and unwelcome development."

Managers now need to generate gains of US$350 billion a year to satisfy investor expectations, he said. That's an annual return of about 12 per cent from the US$2.9 trillion industry, which has returned an average of 2.2 per cent in the past five years.

"Against a backdrop of comparatively sclerotic growth, S&P 500 valuations stretched on numerous metrics, and alongside approximately US$10 trillion of negative-yielding debt, it is reasonable to conclude that the alternatives industry is inappropriately sized to deliver on clients' return expectations," Mr Law, 50, said in an investor letter Tuesday obtained by Bloomberg News.

Mr Law is joining money managers including Peter Kraus at AllianceBernstein in urging the industry to scale back assets to improve performance.

Most active money managers, and hedge funds managers in particular, have trailed the broader stock market for years, prompting clients to push for lower fees or flee to low-cost index products.

New Share Class

Caxton, one of the most expensive hedge funds, said in its letter that it would lower its annual management fee to between 2.2 per cent to 2.5 per cent. It previously charged as much as 2.6 per cent, according to a government filing. The firm will continue to take a 27.5 per cent cut of profits.

Caxton, based in New York, also introduced a new share class that locks up client money for three years and charges a 2 per cent management fee, according to the letter. All the changes take effect in January. Mr Law didn't return an e-mail seeking further comment.

The changes follow similar moves by veteran managers including Paul Tudor Jones and Dan Och. High expenses have been bedrock of the hedge fund businesses, enriching managers as industry assets doubled in size since 2008. Now investors are pressing for relief.

Even with Caxton's cuts, its fees remain above the standard industry rate of 2 per cent of assets and 20 per cent of profits, an expense structure that many managers have stubbornly refused to change even as their performance trailed.

Warren Buffett has described the fees as "a compensation scheme that is unbelievable," and Bill Gross of Janus Capital Group Inc called them a "giant ripoff."

Living Too Well?

"The hedge fund industry was not created for managers to live well on management fee surpluses, but rather to strive for strong and differentiated performance," Mr Law said.

"Whilst it is entirely appropriate that the rewards for great performance continue to be exactly that, it is important to recognise that compensation across the entire financial services industry has moved lower post-global financial crisis."

Caxton had US$11 billion in regulatory assets, which includes borrowed money, according to a government filing. Mr Law said in the letter that controlling asset size is key to delivering returns.

Mr Kraus, CEO of AllianceBernstein Holding, said in June that "it's pretty clear that active managers have not performed above their benchmarks to any great degree." He estimated assets in actively managed funds may have to shrink by as much as 30 per cent to restore their ability to beat indexes.

Macro Strategy

Caxton, which was started in 1983, was one of the first macro funds that seek to profit from macroeconomic trends by trading everything from bonds. It lost 2.6 per cent this year through Sept 2 after posting a 3.5 per cent gain in 2015 and a loss of 1.4 per cent the previous year, according to an investor document.

The average macro hedge fund has returned 1.6 per cent this year through August after losing 0.14 per cent in 2015 and 2.2 per cent in 2014, Bloomberg data show.

Caxton was started by billionaire Bruce Kovner, who ceded control of his firm to Law four years ago. Mr Law, who grew up in Cheshire, England, and earned an undergraduate degree in economics at the University of Sheffield, joined Caxton in 2003.

BLOOMBERG

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