Tough times Brexit Bump Scant Relief for Struggling Hedge Funds

An industry of speculators accustomed to success is finding it difficult to adjust to a financial world in which central banks call the shots. Brexit offered them a brief lifeline.
Darkness decending on New York's hedge fund scene, though Brexit may have helped stave off defeat.

David Harding was one of the most ardent proponents of Britain remaining in the European Union. He even donated £3.5 million ($4.7 million) to the "Britain Stronger in Europe" campaign. It turned out to be money spent in vain as the British voted for Brexit.

It was a stinging personal defeat for Mr. Harding, a billionaire. But the founder of Winton Capital, one of the world's largest hedge funds with about $30 billion (€27 billion) in managed assets, found consolation elsewhere.

While many stock exchanges, like the one in Frankfurt, saw sharp declines of up to 7 percent on the day, and the British pound fell to a 30-year low, Winton Capital’s investments gained 3.1 percent.

On the whole, the hedge fund industry did relatively well on "Black Friday," the day the result of the Brexit vote was announced. Some $5 trillion were wiped off stock exchanges worldwide in a single day. This is twice Britain's annual gross domestic product.

But the $3 trillion hedge fund industry lost only 0.18 percent, according to financial data provider Hedge Fund Research, and it appears they may have gained since.

Many market players were surprised by unexpected events like the weakness of the Chinese currency and the hesitant stance of the U.S. central bank, the Fed, toward raising interest rates. Harald Sporleder, Allianz Global Investors

On any given day, hedge funds will bet on rising or falling prices on stock exchanges, trends in currencies and commodities, price differences on exchanges, and they try to derive profits from corporate mergers and acquisitions.

In the case of Brexit, Mr. Harding had bet on a falling pound and a sinking euro, as the fund wrote in a letter to its clients. Mr. Harding sold the currencies as of a certain effective date. Because the exchange rate was lower than that price, the fund was able to buy back the currencies at a lower price, earning a healthy profit on the difference.

In contrast, other major investors, like hedge fund legend George Soros, had bet on a rising gold price, which also turned out to be the right bet. Crispin Odey, a Brexit proponent, profited when he bet on falling stock prices with his $10-billion hedge fund and won the bet. He had been losing heavily until early June, but the Brexit bet enabled him to make up for some of those losses.

It had long seemed that hedge funds were having the worst half-year in five years. Until three days before the end of June, hedge funds investments were down 1.8 percent. The last time this happened was in the first half of 2011, when losses added up to 2.1 percent.

Following a week of Brexit turmoil on global markets, most hedge funds did manage to miraculously turn things around. The HFRI Fund Weighted Composite, a benchmark for the industry, wound up gaining 1.6 percent in the first half of the year.

That’s still low by past historical standards, and many are unlikely to see the same kind of late bump in the second half of this year.

According to Harald Sporleder of Allianz Global Investors, to weather the storm longer-term, hedge fund managers first need to learn how to cope with the zero interest-rate policy of central banks.

"Many market players were surprised by unexpected events like the weakness of the Chinese currency and the hesitant stance of the U.S. central bank, the Fed, toward raising interest rates," said Mr. Sporleder, a hedge fund manager with the asset management arm of Europe’s largest insurer.


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Around the world, monetary guardians have been either holding or pushing down interest rates. Even those central bankers such as the U.S. Federal Reserve, which are watching over a broadly healthy economy, have been reluctant to raise rates from their record lows.

That in turn has pushed down the yields on a whole range of investments that used to earn money for hedge funds and other asset managers. Consistent returns in this environment have been increasingly hard to come by.

In the first half, results were poor for a number of large hedge funds with assets in the billions.

They include Pershing Square, a publicly traded hedge fund run by Bill Ackman. The manager, long accustomed to success, like a 40-percent return in 2014, incurred major losses last year.

By the end of June, Mr. Pershing was already back in negative territory, down about 21 percent. His problem is a disappointing major investment in shares of Canadian pharmaceutical company Valeant.

The weak performance has prompted some major investors to voice opposition to high fees.

To add insult to injury, Mr. Ackman, an avid tennis player, was defeated in the second annual Finance Cup hosted by the Queen’s Tennis Club in London. As a member of the U.S. tennis team, Mr. Ackman was faced with a defeat against his European counterparts. Luckily for him, there weren’t billions placed on that bet.

Ray Dalio, founder of Bridgewater Associates, the world's largest hedge fund with a total of $150 billion in managed assets, has also suffered. For years, Mr. Dalio was achieving magnificent, double-digit returns. He bets on macroeconomic trends, invests in a large number of markets and tries to distribute risk across various investment classes, the goal being to lower volatility.

But the concept isn’t working anymore, at least not with his flagship Macro hedge fund, which accounts for about 45 percent of total investment volume. It had lost about 12 percent of its value by the end of June – the worst first half-year for the hedge fund since 1995. Bridgewater was unwilling to comment.

Other hedge funds have also experienced losses, like the Viking Global Investors hedge fund run by Andreas Halvorsen, and the Och-Ziff Master Fund.

Marcus Storr, a hedge fund expert with investment manager Feri, describes earnings performance in the first half of the year as "somewhat disappointing," saying that too many hedge funds pursued the same strategies, "but some of their bets did not pay off."

The mixed results come at a bad time for hedge funds, in an industry that saw average losses of 3.5 percent last year. The weak performance has prompted some major investors to voice their opposition to high fees.

As a rule, hedge funds charge a 2-percent annual management fee and receive 20 percent of the profits. The University System of Maryland Foundation has already announced that it intends to review its holdings with hedge funds that are not achieving sufficient returns or are charging fees that are too high.

For the same reason, the $53-billion Alaska Permanent Fund is planning to make its own selection of the hedge funds in which it wishes to invest, no longer relying on the expertise of umbrella funds.

Pension funds from New York City to Orange County, California, are putting their investments in hedge funds to the test. One example is the New York City Employee Retirement System. The $51 billion pension fund plans to exit all hedge fund investments and invest in other investment classes instead. There is a lot of money at stake – $1.5 billion – which had been invested in such well-known funds as Perry Capital and Brevan Howard Asset Management.

Vicki Fuller, top investment strategist for the New York State Common Retirement Fund, the third largest pension fund in the United States, has announced that hedge funds must achieve a certain minimum performance before her pension fund will pay their high fees. Previously, the largest U.S. pension fund, California‘s Public Employees Retirement System, or CALPERS, had exited its investments in hedge funds because it was dissatisfied with the returns after deducting the costs.

As a result of these problems, a growing number of hedge funds have been shut down recently: 291 in the first quarter of 2016, compared to 217 in the previous year, according to HFR.

Nevertheless, confidence remains high in the industry. In light of “a brittle environment for stocks and corporate bonds, active management and alternative risk premiums are becoming more and more important," said Werner Goricki, chief investment officer of investment firm Prime Capital.

Mr. Goricki does not see an end to the decades of growth in the industry.


Peter Köhler covers funds and the investment industry for Handelsbaltt and is based in Frankfurt. Robert Landgraf is Handelsblatt's chief correspondent for the financial markets. To contact the authors: [email protected] and [email protected]