Hedge Fund Managers Lose Their Swagger

Investing ▶ In six months, investors have withdrawn $16 billion ▶ “People are worried about their jobs”

Doug Dillard followed the path that once almost guaranteed entrance into the 1 Percent: Good college (Georgetown), investment bank (Morgan Stanley), MBA (Harvard). Then a hedge fund. A decade out of business school, he was heading Standard Pacific Capital, a multibillion-dollar San Francisco firm that traded global stocks. It did well by its clients, making money in 2008 as markets plummeted.

But Dillard’s returns—like most other hedge fund managers’—failed to keep pace in the post-great Recession bull market. Investors exited. In February, when assets slid below $500 million, Dillard pulled the plug. “It has recently become clear to both of us that sometimes there is a logical conclusion to even a good thing,” he and his partner, Raj Venkatesan, wrote to clients.

They aren’t the only ones thinking their good thing might be gone. On April 26, Third Point manager Dan Loeb, one of the hedge fund elite, wrote to investors that the industry is “in the first innings of a washout.” At the annual Berkshire Hathaway shareholder meeting at the end of April, Warren Buffett told investors to keep money away from hedge funds because of their high fees and lousy returns.

“People are worried about their jobs,” says Edward Magi, who sells real estate for William Pitt Sotheby’s in Southport, Conn., an area popular with hedge funders. He’s seen two multimilliondollar deals fall apart this year because the buyers lost work. Hedge funds have gone through tough patches before, but this one is disquieting, as the broader investing world isn’t in crisis mode. The S&P 500-stock index, after a rocky start to 2016, advanced about 1.3 percent in the first quarter. Hedge funds lost an average of 0.6 percent.

The worry for the hedge fund crowd is that their business model is broken. The funds, generally available only to wealthy investors, may choose to make big bets on just a few ideas, or that securities will fall in value as well as rise. Because their portfolios can differ so much from market indexes, the best can make money even as markets fall. The seeds of trouble were planted after 2008, when the market meltdown convinced many to retreat from junk-grade bonds and other less-liquid securities. Now, roughly half of all hedge fund assets are focused on equities, according to Hedge Fund Research. More managers may be going after a finite set of promising trading ideas, diminishing returns as they crowd in.

What’s more, 312 firms have at least $1 billion in assets, according to a survey published by Absolute Return. Some potentially profitable market niches are too small for these funds to invest in.

Even some high-profile managers are struggling. The funds of Alan Howard and Richard Perry—once consistent winners—were down in the first quarter, after two years of losses. The S&P 500 returned a cumulative 16.7 percent in that period. Bill Ackman of Pershing Square, a manager people followed into whatever stock he bought, has lost $5.5 billion on his core strategy in just 15 months, primarily because of one bet on Valeant Pharmaceuticals.

In the past two quarters, investors have pulled more money from hedge funds than they put in—almost

“It has recently become clear to both of us that sometimes there is a logical conclusion to even a good thing.” —— Doug Dillard and Raj Venkatesan, on closing their hedge fund