The hottest investment for hedge funds is other hedge funds

The world’s biggest hedge funds are flush with more capital than ever—so much so that many are allocating billions of dollars to other firms. (Image: Pixabay)
The world’s biggest hedge funds are flush with more capital than ever—so much so that many are allocating billions of dollars to other firms. (Image: Pixabay)

Summary

Big firms like Millennium are so flush with cash they’re outsourcing it to other firms.

Veteran investor Jonathan Heller recently launched his own hedge-fund firm after amassing about $1 billion. All of the initial money came from another hedge fund.

Izzy Englander’s Millennium Management staked Heller with an option to commit more money over time, people familiar with the matter said. Heller’s firm, Helix Partners Management, trades securities and derivatives tied to companies that are under financial strain or bankrupt, including the former parent company of Silicon Valley Bank.

The world’s biggest hedge funds are flush with more capital than ever—so much so that many are allocating billions of dollars to other firms.

It is a byproduct of the hedge-fund industry forking into the haves and have-nots. Gains at the top 20 hedge-fund managers represented 83% of the industry total over the past three years, according to fund investor LCH Investments. Firms with more than $5 billion under management account for nearly 73% of hedge-fund assets, according to research provider HFR.

Much of that concentration is a result of new assets piling up at multimanager hedge funds. Millennium, Steve Cohen’s Point72 Asset Management, Balyasny Asset Management and other such firms fan out money across dozens to hundreds of teams with distinct investment strategies.

Among multimanager hedge-fund firms tracked by Goldman Sachs’s prime-brokerage unit, 61% now allocate at least some capital to outside firms or managers. That is up from 52% in December 2022.

“Some of these great multimanagers have more capital than they have capacity for," said Roark Stahler, U.S. head of strategic consulting at Barclays’s prime-brokerage unit. “Making an external allocation is a great way to put money to work."

Historically, hedge-fund managers would occasionally outsource a chunk of money to others to manage, especially to employees starting their own firms. What has changed is the structure, size and pace of these arrangements, and the ability to leverage systems that support thousands of internal investment professionals.

Many multimanager firms invest externally via so-called separately managed accounts over which they can set controls and risk limits, view positions in a portfolio and provide financing. Rather than cutting a check that goes into a pooled fund, many offer billions of dollars in buying power off their own balance sheets to outsiders, similar to what they would do to the investment teams they employ.

Seeding new hedge-fund firms this way also gives multimanager firms an avenue to profit from highly-regarded portfolio managers who don’t want to go in-house, said Barclays’s Stahler.

Multimanager hedge funds often bill their investors the compensation costs for outside managers, just as they do with their employees’ compensation. That is more amenable to some fund investors than having to pay separate fees to an outside manager on top of what they pay to a multimanager firm.

Some investors of Woodline Partners, a San Francisco-based hedge-fund firm started by alumni of Citadel, criticized the additional fees they incurred when the firm invested hundreds of millions of dollars in a pooled hedge fund launched by other alumni of Citadel, London-based Ilex Capital Partners, people familiar with the matter said.

One of the most prolific hedge-fund firms making external allocations is Millennium, which currently manages about $68 billion and has a market footprint of about $500 billion including borrowed money. It had done some deals over the years with outside managers, including seeding former executives Feng Guo and Michael Robinson with more than $1 billion when they spun out to launch Symmetry Investments about a decade ago.

Around 2021, the firm upped the tempo of external investments, particularly with portfolio managers with no prior ties to Millennium, often as the exclusive provider of capital for a period, people familiar with the firm said.

Chicago-based Kodai Capital Management, which primarily bets on and against tech stocks, and Burkehill Global Management, a New York-based stock-trading firm, each received money from Millennium around then, the people said.

Millennium recently provided billions of dollars to Taula Capital, a London-based macro hedge-fund firm started by former Millennium trader Diego Megia. Some of the largest launches expected later in 2024 or early 2025, including George Panos’s Sone Capital, are in discussions with Millennium about getting sizable allocations, some of the people familiar with the matter said.

Other multimanager firms are cutting similar deals. Balyasny recently gave Landmark Investment Partners, a West Palm Beach, Fla.,-based hedge fund specializing in real-estate stocks, a chunk of money to invest, people familiar with the matter said.

One holdout is Ken Griffin’s Citadel, which rarely allocates money to other hedge funds and prefers to focus on developing talent internally. It made an exception for Candlestick Capital, a hedge-fund firm started by former Citadel portfolio manager Jack Woodruff in 2019, people familiar with the matter said. Citadel invested in Candlestick with an agreement that includes receiving a share of the firm’s revenues.

Some big quant firms, such as Qube Research & Technologies and Squarepoint Capital, are seeding outside stock and bond pickers to complement their computer-driven trading strategies.

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

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