The giant hedge fund that hates risk and still wins

Millennium parcels out the roughly $69 billion it manages for clients across more than 2,600 traders, analysts and other investment staffers working on hundreds of teams. Each team operates independently, betting on things like bonds converging or which companies get added to stock-market indexes or the outlook for commodity prices. But all of them face unusually tight limits on risk-taking, according to people familiar with the firm’s inner workings.

For example, portfolio managers who are allocated $1 billion can lose only $50 million before that buying power will likely be cut in half. If they lose an additional $25 million, they will likely be fired.

Protecting itself against even modest losses has made Millennium one of the most stable performers in the hedge-fund industry and made Israel “Izzy" Englander, the firm’s chief executive, a billionaire. Millennium has generated $56 billion in gains for investors after fees since the firm’s inception in 1989, according to LCH Investments. Among hedge funds, that trails only Citadel.

Millennium has had a single down year, 2008. Over the past five years, it hasn’t lost more than 1% in any given month.

That kind of longevity and consistency is rare in the hedge-fund world. Many of the most successful traders historically were defined by their risk appetites and track records that featured home-run returns alongside strikeouts. Nowadays, among investors such as pension plans and charitable foundations, go-for-broke hedge funds are out of fashion while those that reliably generate decent gains are in demand.

It is that type of returns that multimanager firms such as Englander’s are designed to deliver. A group of 53 multimanager hedge funds produced annualized gains of 9.9% over the past five years ended in June, outperforming the overall hedge-fund industry, according to Goldman Sachs’s prime-brokerage unit. They did it with less than half as much volatility as other hedge funds and nearly no correlation to the broader stock market.

Englander avoids the spotlight that other famous investors relish and rarely speaks about his fund in public. At a closed-door industry conference last year, fellow hedge-fund manager Paul Tudor Jones introduced Englander as one of the best risk-mitigators ever. When Englander plays the board game Risk, where the whole point is world domination, Jones joked that the Millennium executive is instead focused on “world mitigation."

Millennium and other multimanager funds follow a similar playbook to manage risk. They have several investment teams, sometimes called pods, that operate autonomously with different strategies and asset classes, breeding diversification. These firms tend to run market neutral, or have mostly balanced wagers on rising and falling asset prices. The firms monitor teams’ exposure to the underlying attributes, or factors, that may be present across different securities.

Firms target a level of volatility that they view as acceptable, often resulting in portfolio managers increasing their positions when markets are tranquil and cutting them in times of trouble. Behind the scenes, risk managers might scale back similar bets that a number of different teams take to ensure they aren’t overweight any single position firmwide, usually without the knowledge of those teams.

Where Millennium stands apart is its relatively rigid imposition of so-called stop-losses, or the maximum amount its people can lose before the firm gets involved. A reduction in capital can occur when a portfolio manager is down by 5%. When losses reach 7.5%, that usually means the portfolio manager is out of a job, though Millennium sometimes makes exceptions.

Hedge funds track how big their returns are relative to the risk they took to generate them. Since its inception, Millennium scores a 2.6 on this metric, known as the Sharpe ratio. That is more than double the 1.1 that a broad hedge-fund index achieved over the past five years, according to Barclays.

Millennium’s portfolio managers can operate under a fear of hitting those stop-losses. Many portfolio managers choose to deploy millions of dollars less than they are allotted so as to give themselves more breathing room for losses.

Millennium’s higher turnover also means it constantly needs to find new people to put its money to work. About 15% to 20% of its staff leave each year, and Millennium, like other multimanager firms, offers generous pay packages to new recruits that can reach tens of millions of dollars.

At the conference, Englander cited noncompete agreements at rival hedge funds for the escalating cost of hiring new traders.

As long as their portfolios don’t lose money, Millennium gives employees a long leash. The firm can be less prescriptive than rivals when it comes to telling teams which or how many companies they can cover and invest in. Team leaders often give distinct names to the pods they run, as if they managed a stand-alone hedge fund.

That autonomy extends to how often members of investment teams are required to come into the office. One Millennium portfolio manager, Yao King, owns a farm in Pennsylvania and documents on social media his adventures growing garlic, inspecting his barn for leaks and tapping maple trees for sap. A video posted to Millennium’s YouTube page splices clips of King splitting wood with others of him in front of a trading terminal.

“Whether it’s in farming or in finance, you’re constantly trying to consider what risks you’re not considering," King said.

Write to Peter Rudegeair at peter.rudegeair@wsj.com