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 His prescient short calls such as Allied Capital and Lehman Brothers
had been announced in previous years at the annual Sohn Investment
Conference in New York. And so, as he took the took the stage at the
event after the U.S. stock market closed on May 4, audience members
were eagerly anticipating what would come next.
In a 15-minute presentation, he laid out why industrial company
Caterpillar Inc should trade at half its current value. The next
day, the stock opened lower, but was down just 1 percent.
After a decade in which hedge fund assets nearly doubled, there are
several signs that the golden era for the $2.9 trillion industry may
be on the wane, draining the influence of fund managers who once
considered themselves masters of the universe.
Once able to command hefty fees by routinely beating the Street,
hedge funds are now facing a storm of unsatisfied clients who are
demanding either steep discounts or withdrawing their funds
entirely, leaving some in the industry wondering whether the pain is
just beginning.
The same day that Einhorn spoke in New York, the chief investment
officer for the California State Teachers Retirement System called
the typical hedge fund fee model "broken." A few weeks earlier, the
New York City Employee's Retirement Fund announced that it was
pulling out of hedges completely.
Einhorn is a prime example of the industry's troubles. Last year,
his Greenlight Capital lost 20 percent, marking the fund's first
down year since the 2007-09 financial crisis and only its
second-ever annual loss since its inception in 1996.
Greenlight investors have expressed their disappointment by pulling
money, helping shrink assets to roughly $9 billion, down some $3
billion from only eight months ago.
Einhorn, who declined to comment for this story, acknowledged the
tough new environment when he wrote to investors in January "we have
never had a year where so little went right," and pledged the firm
would "concentrate on trying to make better returns."
FEES FALL AS FUNDS MULTIPLY
In part, the industry is a victim of its own popularity.
With an estimated 10,046 global hedge funds and funds of hedge funds
according to Hedge Fund Research Inc (HFR) - near the record high in
2014 - investors and analysts say that many managers are chasing the
same ideas, driving spreads downward and lowering potential returns.
At the same time, extraordinarily low global interest rates are
keeping a lid on returns from arbitrage strategies that attempt to
exploit differences between global economic policies, for example.
Daniel Loeb, who runs $17.5 billion Third Point, said pointedly in a
recent letter to investors "as most investors have been caught
offsides at some or multiple points over the past eight months, the
impulse to do little is understandable."
Last year the average hedge fund lost slightly more than 1 percent,
according to HFR, but with billionaire stars like Larry Robbins, the
founder of Glenview Capital Management, and William Ackman, the
founder of Pershing Square Capital Management, nursing double-digit
losses.
So far this year the average manager - across all strategies - is
again down nearly 1 percent, while the broader U.S. stock market is
up, albeit slightly.
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As a result, hedge funds are under increasing pressure to lower
their typical fee structure, which charges 2 percent of assets
invested plus 20 percent of gains, or face investors pulling assets
in favor of other illiquid investments ranging from private equity
to real estate, or even low-cost market index funds.
Incentive fees - the amount of investment gains that a hedge fund
manager can take of client gains - fell by an average of 5.3 percent
between the end of 2011 and year-end 2015, according to HFR, and
some wealth advisors say they expect it to fall further.
"When you have too much capital chasing the same ideas and deals,
it's going to narrow the return," said Darell Krasnoff, senior
managing director at Bel Air Investment Advisors, who has halved his
allocation to hedge funds over the last five years and moved money
into commercial real estate instead.
"There's not that many people who can justify 2 and 20 (percent) out
there," he said.
'LACK OF TALENT'?
Overall, investors pulled $15.1 billion out of hedge funds in the
first three months of this year, according to data tracker HFR,
marking the first quarters of consecutive outflows since the
financial crisis.
To be sure, institutional investors such as pensions and endowments
have few safe places to put their billions of dollars with stocks at
relatively expensive levels and many bonds yielding little to
nothing. And recent surveys of large investors showed that many plan
to increase their allocation to hedge funds.
The average allocation among U.S. public pension funds to hedge
funds is up slightly this year, to 9.2 percent of assets from 9
percent the year before.
Yet public criticism has grown more common, even from within the
financial industry.
A day before Einhorn's speech, commercial insurer AIG Inc <AIG.N>
blamed poor hedge fund performance for its lousy quarterly earnings
results and said it would be pulling $4.1 billion it has invested in
the industry.
The day before that, billionaire investor Steven Cohen, who now
manages $11 billion for so-called family office Point72, told an
audience at the Milken Institute Global Conference in Los Angeles
that the days of funds routinely generating 30 percent annual
returns were over.
"Frankly, I’m blown away by the lack of talent," he said.
(Reporting by David Randall, Svea Herbst-Bayliss and Lawrence
Delevingne; editing by G Crosse)
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