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These Hedge Funds Are Doing Great but Don't Want Your Money

29 Jul 2018 1:00 pm
By Gregory Zuckerman 

All the money in the world can't get you into some of the world's best hedge funds.

Multibillion-dollar funds operated by Renaissance Technologies LLC, PDT Partners, WorldQuant LLC, Two Sigma Investments LP and other computer-driven "quant" firms have generated market-beating returns for years, according to people close to the firms, sparking heated investor interest. Renaissance's Medallion fund, for example, has averaged annual gains of more than 35% since 1990, and was up approximately 10% this year through July 20, the people say.

There is a catch, however.

These funds are generally available only to employees, early clients and a few lucky others, part of an effort to limit their size and keep them nimble enough to continue racking up gains. For pension funds, endowments and other big investors, being shut out of these exclusive funds is a bit like peering into a hot nightclub that only allows VIPs inside.

As a result, these investors are left with two options.

They can invest in the hundreds of hedge funds that are less appealing than ever as the industry struggles with another year of middling returns. Or, they can invest in the "open" funds of these successful managers. The results of these open funds generally aren't as strong as the exclusive employee funds, and they can carry an array of potential conflicts, investors say.

Despite the drawbacks, investors have been choosing this option en masse, making these outside funds among the hottest products on Wall Street.

"It's a big challenge," says Theodore Liu, director of investment research at Silver Creek Capital Management, a Seattle firm that invests in hedge funds for clients and has put money in funds operated by some of these firms. "Do you wait and keep begging" to get into the exclusive, proprietary funds, or "do you invest in their A-minus product that may still be very good."

All kinds of investors have shifted to these outside funds, including Blackstone Group's Blackstone Alternative Asset Management, one of the largest investors in global hedge funds, as well as smaller firms, according to people close to the matter.

Last month, Igor Tulchinsky's WorldQuant raised $2.3 billion for its first hedge fund available to outside clients, one of the largest fund launches in recent years. For the past 11 years, the quantitative investment firm has quietly generated strong returns investing billions of dollars for a single client, Israel Englander's $35.3 billion hedge fund Millennium Management LLC. WorldQuant will continue to invest for Millennium, even as it operates the new fund for outsiders.

Renaissance, founded by former cryptographer James Simons, has raised more than $15 billion over the past two-and-a-half years for its own outside funds, helping Renaissance top $57 billion in total assets, investors say, up from $27 billion in 2015. Renaissance began these funds in 2005, well after the firm pushed its last outside investors out of its Medallion fund in 1993, leaving just the firm's employees as investors.

The Renaissance outside funds have beaten the market, though they haven't done nearly as well as Medallion, which manages about $10 billion. The $24 billion Renaissance Institutional Equities, for example, was up 4.9% through July 20, topping a gain of 1.2% for the average hedge fund, according to HFR. Last year, the fund gained 15.2%, besting the 8.6% gain for the average hedge fund.

Two Sigma's outside hedge funds have had mixed results so far this year, with most flat or up about 5%, investors say. Two Sigma manages $54 billion, up from $5 billion in 2010, thanks in part to surging interest in its own outside funds.

Some investors have skepticism about funds run by firms that also manage internal funds, especially if they pursue similar strategies. Amanda Haynes-Dale, co-founder of Pan Reliance Capital Advisors, says she is worried that firms may be tempted to place their best investments in the exclusive funds before allocating to the public funds. In one example of how that would hurt the public fund, a firm buying Facebook shares throughout the day may put the cheapest shares in an internal fund and shares purchased at higher prices in the public fund.

She says investors also need to be vigilant that public funds don't bear the brunt of general expenses racked up by the firm.

"My first question is about securities selection," she says. "I'd be bothered if I was receiving less favorable pricing and proportionally fewer shares of 'hot issues' that can turbocharge returns."

After big European hedge fund BlueCrest Capital Management launched an internal fund for its partners in 2011, it saw much better returns compared with funds BlueCrest offered to outsiders, investors say. Advisory firm Albourne Partners Ltd. raised questions about how the fund was run. Eventually, BlueCrest closed its outside funds and now the firm's founder, Michael Platt, runs a fund trading his own money. Mr. Platt wouldn't comment.

Quant firms like Two Sigma generally have algorithms that automatically generate and fill trade orders without knowing how the shares will be allocated, which can avoid the risk of prioritizing the internal fund, investors say.

The quant firms also sometimes have internal funds that trade in different ways than their outsider funds, which can reassure investors worried about conflicts. Renaissance, for example, uses less leverage, or borrowed money, in its public funds, while also holding on to securities for longer periods than it does with the Medallion fund.

Write to Gregory Zuckerman at gregory.zuckerman@wsj.com

(END) Dow Jones Newswires

July 29, 2018 09:00 ET (13:00 GMT)

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