Conference Presentation, Panel, Fireside Chat
The Evolution of Hedge Fund Management
- Industry Context & Participants: The panel, moderated by Eric Schatzker at the Milken Institute Global Conference 2018, included Dawn Fitzpatrick (CIO, Soros Fund Management, $7B managed internally, 70% direct/30% third-party), Ricky Sandler (CEO/CIO, Eminence Capital, $7B AUM, 20-year track record), Andrew Felstein (CEO/CIO, Blue Mountain Capital, $20B+ AUM, includes $10B in CLOs), and Dimitri Baljasny (Founder, Baljasna Asset Management, $10B AUM, 600 employees, focus on uncorrelated strategies).
- The "2 and 20" Model: Fitzpatrick stated the industry has moved beyond the "2 and 20" fee structure, citing investor sophistication in separating beta from alpha, a focus on fee alignment, and compressing management fees as assets grow.
- Industry Underperformance Drivers:
- Baljasny attributed the post-crisis "mediocre returns at high fees" to a shift where portfolio construction prioritized "protecting downside" over "making money," turning managers into asset gatherers rather than return creators.
- Fitzpatrick noted a limited pool of aggregate alpha, estimating only ~300 billion in annual alpha exists against $3 trillion in industry assets, forcing intense competition.
- Sandler argued that while dispersion exists, the market dynamic has changed from a bull market environment where "easy money" bid up prices, requiring managers to now focus on both fundamentals and market narratives.
- Fitzpatrick highlighted the rise of passive investing, which historically provided alpha opportunities for active funds but now requires greater patience as passive flows have altered market liquidity and pricing mechanics.
- Scaling and Institutionalization:
- Felstein and Baljasny both emphasized that sustainable alpha generation now requires significant scale to fund technology, data science, and talent; Felstein suggested a minimum $100 million annual expense base is necessary to compete for a 10-year horizon.
- Fitzpatrick noted that while small, niche funds offer uncorrelated returns, the industry is undergoing consolidation, with capital increasingly flowing to larger platforms capable of diversifying capabilities and bearing fixed costs.
- Sandler cited the need for scale to support a dedicated short-only team and a robust research infrastructure, noting that "managing down" is difficult without the resources to absorb volatility.
- Baljasny described a shift toward a "barbell" approach: needing specialized teams for deep alpha generation while maintaining a larger platform to provide generalist oversight and resource sharing.
- Strategic Evolution and Innovation:
- Felstein detailed Blue Mountain's heavy investment in quantitative equity and systematic credit, noting that systematic strategies employ significantly more people per billion dollars of capital (30-40) compared to discretionary strategies (<10) to research signals and execution.
- Baljasny described an evolution from purely fundamental long-short to a hybrid model where fundamental ideas feed into quantitative engines, separating research assembly from trading execution to improve efficiency.
- Sandler revealed Eminence Capital increased its research team from 16 to 23, focusing growth on quantum data science (to augment, not replace, fundamental analysis) and building a dedicated short-only team to handle concentrated risk.
- Fitzpatrick emphasized Soros Fund Management's strategy of co-investing internally where possible but outsourcing to niche specialists (e.g., onshore China, biotech) where external managers have superior local expertise.
- Fee Structure Evolution:
- Panelists agreed the industry is moving toward dynamic, alpha-based fee structures, potentially paying performance fees only on true alpha while investors pay a low fee for beta exposure (e.g., 1% management fee vs. 30% of alpha).
- Sandler and Felstein proposed longer crystallization periods (5–7 years) and "co-investment" models where managers and investors agree to lock up capital in exchange for the manager's ability to invest heavily in technology and infrastructure.
- Fitzpatrick warned that while fee compression is inevitable for average returns, investors should be willing to pay premiums (up to 30%) for persistent, differentiated alpha, provided the manager's economics are transparent.
- The group identified "adapt or die" as the new cultural imperative, with innovation and the ability to evolve strategies now viewed as the primary source of persistent alpha.
- Future Return Outlook:
- Relative Performance: All panelists anticipate hedge funds will perform better relative to broad markets (long bias) over the next 3–5 years, as long-bias strategies are currently overextended.
- Cyclical Factors: Sandler and Felstein expect a favorable cycle ahead as capital retreats from crowded hedge fund strategies, reducing competition and allowing survivors to capture higher returns.
- Absolute Returns: Fitzpatrick cautioned that while excess returns (alpha) will improve for top managers, absolute returns may remain lower due to the late-stage nature of the current market cycle and elevated asset prices.
- Consolidation: The panel agreed that the market will favor a smaller number of large, diversified firms capable of cross-strategy execution, alongside a select group of highly specialized, capacity-constrained niche players.